After tough 2023, is it time for a REIT reprieve?

When the history book is written on real estate investment trusts, 2023 won't be earning a place as one of the standout years.

The last 12 months saw plummeting returns for the publicly traded version of the trusts, commonly known as REITs. The National Association of Real Estate Investment Trusts (Nareit) noted in a recent report that REIT shares, which are traded on public exchanges like stocks, fell by about 21% from January 2022 to the start of December this year.

Compare that with the more than 25% gain seen in the S&P 500 in 2023 and the more than 40% gain in the tech-heavy Nasdaq. Despite REITs seeing a small rise in value in the closing months of the year, "it is unlikely that 2023 REIT returns will create lasting happy memories for investors," wrote John Worth, the executive vice president for research and investor outreach at Nareit.

A side path to real estate
For many financial planners, REITs offer clients a way to invest in real estate without the headaches that come with owning actual property. Rather than having to worry about collecting rent and making repairs on apartments and office buildings, they let investors leave those tasks to others and simply bring in income. REITs also offer investors a way to gain exposure to an asset that has consistently risen in value overtime, even if there are down years like 2022 and 2023.

Scott Bishop, a partner and managing director at the Houston-based advisory firm Presidio Wealth Partners, said REITs' recent poor performance doesn't necessarily mean investors should bemoan having them or start looking to stow their money elsewhere. Bishop noted in an interview that the point of having a diversified portfolio isn't to beat the performance of stocks or any other particular type of asset.

"If all of your investments were up by 40% last year, it means you did not have diversification," Bishop said. "You grow wealth through concentration. You protect wealth through diversification.

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"So having a diversified portfolio means all of your pieces are not going to be Magnificent Seven stocks," he added, referring to shares in Apple, Alphabet (Google), Amazon, Meta (Facebook), Microsoft, Nvidia and Tesla. Those seven companies get most of the credit for the stock market's surge last year.

Bishop said his firm usually recommends its clients put as much as 30% of their money into alternatives to stocks and bonds. And of those alternative investments, real estate can make up anywhere from a fifth to half of the total.

Nareit lays the blame for the decline in the price of publicly traded REITs largely at the feet of rising interest rates. In a bid to combat inflation, the Federal Reserve hiked rates from near zero to between 5.25% and 5.5% in 2022 and 2023. Since many real estate purchases are made with borrowed money, higher rates make it harder to enter into new deals or refinance old ones.

But with Fed officials suggesting the hikes are at an end and rates could even come down this year, Nareit sees brighter prospects for 2024. 

"Though REITs have typically experienced relative total return underperformance during Fed tightening cycles, they have outperformed both private real estate and equities in post-rate hike periods," Worth wrote. "With the Fed at or near the end of its interest rate hike cycle, this bodes well for 2024 REIT performance."

Pros and cons of private REITs
Rather than REITs bought and sold on public exchanges, Bishop said he tends to favor their privately traded cousins, which are typically sold through financial advisors. Private REITs offer investors the same exposure to real estate without some of the volatility that can come with funds traded on public markets.

But with that stability often come barriers to removing money from private REITs. Many investors in the largest non-traded REIT — the Blackstone Real Estate Income Trust — learned that lesson in late 2022 when, to their chagrin, Blackstone announced it was exercising its right to put the brakes on attempts to withdraw funds. BREIT, as the trust is commonly known, can put up its redemption gates when 2% of the money held in its real estate investment trust is taken out in a single month or 5% in a given quarter. 

BREIT announced in a letter to its shareholders on Jan. 2 that requests for withdrawals in December fell below the 2% threshold for the first time following 12 months of redemption limits. All told throughout that period, according to the letter, BREIT has been able to return $14.3 billion to investors.

"We are pleased that BREIT has delivered an 11% annualized net return since inception seven years ago (January 1, 2017), nearly 3x publicly traded REITs, and has outperformed its non-traded REIT peers by more than 600 basis points over the last year," the letter states.

BREIT argues in its January letter that it has been shielded from falling real estate values largely because it tends to invest in higher-quality properties. Much of its money is in student housing and data centers in the Sun Belt, one of the fastest-growing regions of the country.

But Kevin Gannon, the chairman and CEO of Robert A. Stanger & Company, said he thinks non-traded REITs are in for more of a correction. Stanger, an investment banking firm that tracks the REIT industry, recently reported that non-traded REITs raised $9.8 billion through November last year while seeing $17.4 billion go out the door during the same period.

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Gannon noted the value of non-traded REITs is down only by 5.4% on average while traded REITs are down by 27% over roughly the same period. He said he thinks investors look at such figures and conclude non-traded REITs remain overvalued. 

"And they say, 'I'm not going to put more money in at this time, and now I'm going to redeem some out,'" Gannon said. "And that's kind of what's going on."

Because of the liquidity concerns surrounding non-traded REITs, some industry watchdogs have called for stricter regulation. But Gannon said he sees investors' redemption requests as a sign of a functioning market. 

"I think what you're seeing unfold here is that investors are smarter, they're focused," he said. "They've got a lot more information. And they're making decisions that make sense."

Riding out REITs to returns 
Bishop said the key to investing in REITs for him is to be discerning. He said he shies away from publicly traded REITs in part because they tend to be invested in older properties that can need to be refinanced, making their values partially susceptible to rising interest rates.

But investors who are going to put money into a new trust that's acquiring properties need to have confidence that the fund managers know what they're doing, Bishop said. That's why, he said, it's essential for advisors and their clients to devote time to studying REITs — learning not only what types of real estate they plan to buy but also where — before investing in them.

After long favoring investments in apartments, Bishop said, he has begun to turn his attention to retail properties, where falling values could soon put some bargains on the market. And sometimes, he said, knowledge and expertise in the real estate market are worth paying a bit more for.

"So having it as part of your portfolio is great, and making sure the fees you're paying aren't outrageous is great," Bishop said. "But I'd rather pay more of a fee for a manager that's good, versus less for a manager that has legacy issues, and maybe doesn't have the track record."