REIT Executives Outlook in a Rising Interest Rate Environment

Recapping the 2023 NYU REIT Symposium – “Mind the REIT Gap”

Recently, Armada ETF Advisors attended the NYU Schack REIT Symposium where multiple REIT CEOs and industry participants spoke on panels with topics such as:

  1. Navigating Complex Currents: Interest Rates, Valuation Gaps, Inflation, Capital Markets, and Changing Business and Regulatory Dynamics
  2. Deals in Complicated Times – M&A, Activism, JV & Fund Models, Structures Outside the Box
  3. Getting Ahead of the Digital Tide
  4. Convergence: Will COVID and its Aftermath Blur the Sectors and Other Lines?

In addition, participants got to hear one-on-one interviews with:

  1. Ron Havner – Chairman of the Board at Public Storage
  2. Sam Zell – Founder & Chairman of Equity Group Investments
  3. Nadeem Meghji – Head of Blackstone Real Estate (Americas)

As part of the industry roundtables, participants heard from REIT industry leaders including:

  1. Conor Flynn (CEO of Kimco Realty)
  2. Mark Parrell (President/CEO of Equity Residential)
  3. Edward Pitoniak (CEO of VICI Properties)
  4. Owen Thomas (Chairman/CEO of BXP)
  5. Christina Chiu (EVP/COO/CFO of Empire State Realty Trust)
  6. Colin Connolly (President/CEO of Cousins Properties)
  7. Benjamin Schall (CEO/President of AvalonBay Communities)
  8. Michael Bilerman (EVP/CFO/CIO of Tanger Factory Outlet Centers)
  9. Scott Brinker (President/CEO of Healthpeak Properties)
  10. Andrea Olshan (President/CEO of Seritage Growth Properties)

In addition, other speakers included:

  1. Mike Graziano (MD at Goldman Sachs)
  2. Guy Metcalfe (MD/Global Chairman of Real Estate at Morgan Stanley)
  3. Matthew Lustig (Chairman of Investment Banking, North America & Head of Real Estate and Lodging at Lazard)
  4. Mary Hogan-Preusse (Senior Advisor at Fifth Wall)
  5. Nick Joseph (Head of US REIT & Lodging Team at Citi Research)
  6. Lisa Kaufman (Head of LaSalle Global Solutions at LaSalle Investment Management)
  7. Gina Szymanski (Director and PM at AEW Real Estate Securities)
  8. Cedrik Lachance (Director of Research at Green Street)
  9. Jefrey Horowitz (Global Head of Real Estate & MD, Gaming/Lodging Investment Banking at BofA)
  10. Kristin Gannon (MD at Eastdil Secured)
  11. Tom Grier (Global Head of Real Estate Investment Banking at JP Morgan)
  12. Brendan Wallace (Co-Founder & Managing Partner at Fifth Wall)
  13. Lauren Hochfelder (Co-CEO & Head of Americas, Morgan Stanley Real Estate Investing MD)

To kick off the conference, some “predictions” were made by Adam Emmerich, Partner at Wachtell, Lipton, Rosen & Katz, including:

  • REITs are hesitant for M&A in current environment
  • REITs need to keep up with technology for the evolving digitization of the economy
  • ESG remains at the forefront of good management teams and investor interest
  • Activism will continue to grow noting that managing it actively and proactively is important for management teams
  • Sunbelt will still be an important trend and continue to drive future planning for REITs

Some interesting comments were made by executives in the first panel looking at interest rates, cap rates and the current lending environment.

  • Equity Residential (EQR) sees 3-6 million units of housing lacking in supply
  • VICI Properties (VICI) continues to focus on the ability to transition from offense to defense (and back again) by having “ability to anticipate” noting that it takes time to formulate new insights…think about how real estate impacts and influences live, work, & play
  • Kimco Realty (KIM) highlights that supply/demand is in the landlord’s favor right now and notes that potential distress and opportunities are on the horizon…”collect your nuts for winter”
  • VICI highlighting cyclicality vs. secular trends noting the aging of baby boomers (and how to spend their time and money over the next 10-20 years) versus millennial family formation (and the growth of Great Wolf partnership as an example)

Executives spent time highlighting their balance sheet management in the wake of a rising interest rate environment as well as the current cap rate environment. It was noted multiple times throughout the day “how do you assess cap rates if nothing trades?” Depending on the sector and credit rating of each company depends on the ability of raising capital. Many executives noted that the fixed income market is opening back up while the equity market is basically closed considering the discounts to NAV where the stocks are trading. Each company takes a different approach to its NAV and highlighted why they think their various companies are trading at discounts.

During the second panels, executives noted that:

  • The importance of boards to focus on leverage and where to deploy capital
  • AvalonBay talked about how they must be prepared for a wider set of outcomes and take steps to enforce its balance sheet strength such as “match funding” its development.
  • Cousins noted that “office is not dead” with their occupancy approaching pre-pandemic levels but that note that there are too many office buildings and thus its trying to find the new equilibrium.
  • Empire State Realty Trust highlighted its capital allocation strategy as an operating runway as they try to create an all-weather balance sheet. They highlighted the dividend cut during COVID and bringing it back at a smaller level as they wait for Observatory to fully recover. They stressed the importance of having “a path to a strategy”.
  • AvalonBay also comments how apartment REITs have an advantage compared to private players (as they see favorable lending terms) and thus there are opportunities in the market. As an example, they are seeing land discounts at 30-35% versus a year ago.
  • The topic of a company being “pure play” was covered heavily as Empire State (as an example) has Office tenants, a tourism business (with Observatory), retail tenants and residential tenants. They covered every office player and noted how none of them are truly “pure play”.
  • Lazard highlighted the cost of debt/equity access in the markets plus seeing capital coming in from Asia and the Middle East. They note that the capital markets are what is driving deal activity and REITs have the lowest discount rate on their costs of capital. They note that sovereign wealth funds are saying “why should I buy the assets when I can buy the stock price?”

On the investor panel roundtable, executives commented that:

  • Investors are betting on growth in an inflation/rising interest rate environment through sectors such as Residential and Industrial. They note that bank failures mean that balance sheets across the board are in focus.
  • Investors are seeing select opportunities in multiple sectors including industrials, residential, shopping centers, storage, and lodging plus secular growth tailwinds benefiting sectors such as storage, towers and single family rentals.
  • Are the troubled sectors getting cheap enough? Is now the time to start looking at office, hotels, billboards? Have to focus on the total return but its important to be cautious before jumping in front of a potential dividend cut or troubled situation.
  • Green Street mentioned that office is not attractive in the private markets while the public market asset values are down 50%. They note the importance of being choosy as the Sunbelt may be the most appealing based on value/return but the key is to focus on the total return potential (not just the dividend) and look at the cash flow generation of the business.
  • Citi noted that dividends in the REIT sector are currently at 70% of cash flows. In addition, they commented on the balance sheet strength and financial position these companies are in versus 2008 and note that most companies are in a better position in this downturn than the past.
  • On Shareholder Activism: “be open to feedback…it’s a good thing”. Activism may be a pain and expensive to a management team but if they listen, then a better company could come out on the other side. “A bad board opens itself to activism”.
  • On REIT Boards: Be open to the idea of long-term value creation. Be knowledgeable, be engaged on all facets of the business. Focus on the business risks. Focus on the management team composition…is it right? Are the right people in the right seats? Green Street noted the importance of board term limits and the willingness to potentially sell a company (since the board should be a temporary gig).
  • On Public v. Private Valuations: Citi noted that public markets have shown that cap rates have moved up but there is a wide bid/ask spread and as more debt comes due, we’ll see more deals get done. Green Street noted that real rates have moved 200-300 basis points in the past 15 months with no changes in asset value growth. The public markets have factored in a 25% decline in asset values and it should lead to a repricing in the private markets which should lead the publicly-traded REITs being more active in the marketplace over the next 6-12 months.
  • Some great quotes from AEW: “Embrace the volatility”, “Learn the power of resilience”, “Work ethics fixes a lot of problems”, “Control what you can control”, “Don’t be so afraid to make a mistake”, “Surround yourself with good people…have a personal board of directors”

Executives spent time in the next panel looking at how the cloud and digital infrastructure is transforming the REIT industry. AI was a constant topic throughout the day. During the panel, JP Morgan noted that “the cloud” is growing at a 20% compounded annual growth rate and it makes sense that 5 of the largest 10 EITs are in the digital infrastructure space since the outlook for the sector is positive and multiple companies are reporting record leasing. They do note that land, power supply and labor are challenges in the sector. Fifth Wall noted that “the line between tech and real estate is getting blurry”. In addition, “tech is the connective tissue that makes companies like Invitation Homes work”. As far as the impact of AI, the executives noted that AI wouldn’t disrupt a hotel ballroom as physical buildings don’t generate structure data but we need the physical space “to do civilization and the economy”.

In the last panel section, executives commented on COVID’s impact noting that:

  • “COVID reinforced bricks & mortar retail” said Michael Bilerman as he cites the store drives volume in local markets. Deliver optionality to the consumer that they want. “Bring as much to the consumer as possible in which the real estate surrounding it provides for”. The main goal is to drive NOI but the deal has to stand on its own and he commented on how Tanger has evolved its properties with more experiential concepts for the entire family.
  • Bilerman also commented on how Amazon hasn’t figured out the logistics issue, when hypothetically, we would see a couple of Amazon delivery drivers bringing us packages everyday versus one driver bringing all of the orders to us at one time.
  • Seritage highlighted how they look at the best use for each big box of space they have. They are seeing residential interest in some of its parcels. In addition, they note that some of their secondary markets are “booming”.

Other notes from the conference:

  • Ron Havner noted the competitive advantage of REITs in the market in that they have a currency in the form of stock to fund deals.
  • He cited the Warren Buffett philosophy of “the tide is going out and we are about to see who doesn’t have swimsuits”. Thus, it is important to have a “fortress balance sheet” since we don’t know what will happen and its important to be prepared for opportunity.
  • Blackstone noted that they have done their best investing during times of volatility. They commented that fundamental in their core sectors remain the strongest that they have ever seen.
  • Blackstone noted that the sectors with which they have the long-term convictions continues to remain the same as they ask where is the secular long-term growth?
  • They note that AI will continue to increase the demand for data center space
  • “Invest in hard assets that we know will win…price matters but secular tailwinds is more important”
  • “Public markets are sentiment driven and doesn’t reflect the true value of the real estate”
  • Blackstone talked about 70/80/90: “~70% concentrated in the fast-growing South and West; ~80% focused on the top performing rental housing and industrial sectors; and benefits from ~90% fixed-rate financing (BREIT website)”

Sam Zell quotes from his interview:

  • His thoughts on work from home: “It’s bull$h(t”
  • “Entrepreneurship is a skill, not a science”
  • “Am I getting paid for the risk?”
  • “Margin is the lifeblood of an entrepreneur”
  • “The opportunity is always there. It takes the right people to understand it and take advantage of it”
  • “I never buy markets, I respond to opportunities”
  • “My biggest success was buying in Toledo”
  • “As an investor you look for stability as it produces results”
  • “I wouldn’t want to be an owner of Class B office space”
  • “How do you develop people? Skills are developed…you aren’t born with it”
  • “Every moment is a moment of opportunity…everytime you are a seller you are also a buyer”

Who would have thought that the 27th NYU Schack Institute REIT Symposium would have been so relevant with all that is going on in the sector? With the public vs. private debate heating up as we approach earnings season, it was a fascinating day listening to all of these REIT/Real Estate industry professionals share their insights in the wake of a rising interest rate environment.

The key takeaway is that every single member of these management teams is focusing on where the puck is going. How can we be opportunistic in this economic climate by adding shareholder value? How can we continue to improve our balance sheet strength so that we can be opportunistic should the right deal come along? What do we need to do to stave off activist investors? How do we continue to focus on long-term value creation?

These are questions that ALL REIT investors want their management teams to focus on.

* ESG investing is defined as utilizing environmental, social, and governance (ESG) criteria as a set of standards for a company’s operations that socially conscious investors use to screen potential investments.

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