Home Insights Real estate Credit crisis? Why this time may be different for REITs

Credit crisis? Why this time may be different for REITs

June 2, 2023 | 4 min read
Todd Kellenberger, CFA
Client Portfolio Manager, Real Estate Securities
Download PDF
linkedin icon link icon

“Credit crisis” and “banking stress” are dominating headlines and creating uncertainty for capital markets. Real estate is a capital-intensive industry and depends on well-functioning capital markets to thrive.

We believe recent events will likely result in tighter lending standards and translate into lower credit availability and wider credit spreads for real estate broadly. While this is an unwelcomed event and investors likely recall memories of a tough credit crisis for REITs in 2008, we believe this time may be different and the large underperformance of REIT stocks due to credit market concerns is likely overdone.

Exposure to traditional office space is only 3% of the overall U.S. REIT market

The office sector, and its struggles, are receiving large and warranted attention with the lasting impact from work from home and sluggish return to office trends. While office grabs the headlines and much of the negative sentiment towards real estate, it’s a sector that barely moves the needle for the U.S. REIT market.

The drawdown of office stocks has been so great that it’s only about 3% of the overall REIT market today. The public REIT market has changed drastically since the 2008 credit crisis. We believe the increase in non-traditional sectors (single family rental, self-storage, wireless towers, etc.) is a positive as many of these sectors have structural demand drivers to provide earnings resiliency in a more challenging macro environment. Non-traditional sectors continue to be targets of debt and equity capital allocators as well.

EXHIBIT 1: U.S. REIT sector exposure 2007 vs. 2023

Stacked bar chart comparing U.S. REIT sector exposure in 2007 vs. 2023

As of 31 March 2023. Source: FactSet, NAREIT. Change in sector weights are from the FTSE NAREIT Equity REITs index – Other traditional includes industrial, retail, and multi-family residential; non-traditional includes healthcare, hotels, self-storage, net lease, data centers, specialized residential, diversified, other, and land/timber. Indices are unmanaged and do not take into account fees, expenses, and transaction costs and it is not possible to invest in an index. Percentages may not add up to 100% due to rounding.

REITs are less reliant on banking financing than commercial real estate broadly

REITs have well-diversified sources of capital given their listed status and generally strong balance sheets. In fact, REITs source over 85% of overall capital from listed unsecured bond and equity markets1. We estimate only 20-25% of total debt capital comes from banks versus approximately 35-40% for commercial real estate more broadly. When REITs are sourcing debt capital from banks, it’s primarily in the form of term loans or revolvers using very large, well-capitalized banks. REITs typically do not source bank loans from regional or community banks.

REIT balance sheets are in a far stronger position than entering the 2008 crisis

The 2008 credit crisis taught some painful lessons for real estate investors, and it resulted in major balance sheet improvement by REITs in the last 15 years. The emphasis on deleveraging by REIT management teams gives them greater financial resiliency to weather a pullback in real estate capital markets and could potentially give them the flexibility to capitalize on any distressed opportunities.

EXHIBIT 2: U.S. REIT financial metrics: 2007 vs. 2023

Table of U.S. REIT financial metrics in 2007 vs. 2023

As of 31 March 2023. Source: FactSet, NAREIT.

A large refinancing wave is coming for U.S. real estate, but not for REITs

It’s estimated $1.4 trillion of the $5 trillion (i.e., 28%) of U.S. commercial real estate debt outstanding expires in 2023 and 20242. The percentage of debt expiring for U.S. REITs over this same time period is only 12.8% and remains modest in 2025 as well. Debt markets have remained open this year, with several companies issuing bonds, private placements, or securing mortgages. Property cash flow disruption and the inability to refinance is a concern for office, a sector with limited exposure in REIT markets.

EXHIBIT 3: U.S. REIT debt maturities over the next three years are manageable

Bar graph of U.S. REIT debt maturities over the next three years

As of 31 December 2022. Source: Principal Real Estate, Morgan Stanley, FactSet.

In summary, in an environment of increased risk, the stronger financial health of the REIT market and relatively modest exposure to office are important reasons why REITs may better weather any credit crisis storm that comes their way. This is perhaps misunderstood in the market as REIT stocks have lagged other equities by a large margin this year and trade at wide discounts to private real estate. The market’s recognition of this dislocation could be the catalyst for REITs to be back in favor once again.

1 Factset, NAREIT, 31 December 2022.
2 Moody’s . “What’s the Real Situation with CRE and Banks: Doom Loop or Headline Hype”, April 2023.

Real estate
Disclosure

For Public Distribution in the United States. For Institutional, Professional, Qualified, and/or Wholesale Investor Use Only in other Permitted Jurisdictions as defined by local laws and regulations.

Risk Considerations
Investing involves risk, including possible loss of principal. Past performance does not guarantee future return. All financial investments involve an element of risk. Therefore, the value of the investment and the income from it will vary and the initial investment amount cannot be guaranteed. Potential investors should be aware of the risks inherent to owning and investing in real estate, including value fluctuations, capital market pricing volatility, liquidity risks, leverage, credit risk, occupancy risk and legal risk. All these risks can lead to a decline in the value of the real estate, a decline in the income produced by the real estate and declines in the value or total loss in value of securities derived from investments in real estate. economic conditions. Investing in REITs involves special risks, including interest rate fluctuation, credit risks, and liquidity risks, including interest conditions on real estate values and occupancy rates. Asset allocation and diversification do not ensure a profit or protect against a loss.

Important Information
This material covers general information only and does not take account of any investor’s investment objectives or financial situation and should not be construed as specific investment advice, a recommendation, or be relied on in any way as a guarantee, promise, forecast or prediction of future events regarding an investment or the markets in general. The opinions and predictions expressed are subject to change without prior notice. The information presented has been derived from sources believed to be accurate; however, we do not independently verify or guarantee its accuracy or validity. Any reference to a specific investment or security does not constitute a recommendation to buy, sell, or hold such investment or security, nor an indication that the investment manager or its affiliates has recommended a specific security for any client account. Subject to any contrary provisions of applicable law, the investment manager and its affiliates, and their officers, directors, employees, agents, disclaim any express or implied warranty of reliability or accuracy and any responsibility arising in any way (including by reason of negligence) for errors or omissions in the information or data provided. All figures shown in this document are in U.S. dollars unless otherwise noted.

This material may contain ‘forward looking’ information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader.

This material is not intended for distribution to or use by any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation.

This document is issued in:

  • The United States by Principal Global Investors, LLC, which is regulated by the U.S. Securities and Exchange Commission.
  • Europe by Principal Global Investors (EU) Limited, Sobo Works, Windmill Lane, Dublin D02 K156, Ireland. Principal Global Investors (EU) Limited is regulated by the Central Bank of Ireland. In Europe, this document is directed exclusively at Professional Clients and Eligible Counterparties and should not be relied upon by Retail Clients (all as defined by the MiFID). The contents of the document have been approved by the relevant entity. Clients that do not directly contract with Principal Global Investors (Europe) Limited (“PGIE”) or Principal Global Investors (EU) Limited (“PGI EU”) will not benefit from the protections offered by the rules and regulations of the Financial Conduct Authority or the Central Bank of Ireland, including those enacted under MiFID II. Further, where clients do contract with PGIE or PGI EU, PGIE or PGI EU may delegate management authority to affiliates that are not authorized and regulated within Europe and in any such case, the client may not benefit from all protections offered by the rules and regulations of the Financial Conduct Authority, or the Central Bank of Ireland.
  • United Kingdom by Principal Global Investors (Europe) Limited, Level 1, 1 Wood Street, London, EC2V 7 JB, registered in England, No. 03819986, which is authorised and regulated by the Financial Conduct Authority (“FCA”).
  • United Arab Emirates by Principal Global Investors LLC, a branch registered in the Dubai International Financial Centre and authorized by the Dubai Financial Services Authority as a representative office and is delivered on an individual basis to the recipient and should not be passed on or otherwise distributed by the recipient to any other person or organisation.
  • Singapore by Principal Global Investors (Singapore) Limited (ACRA Reg. No. 199603735H), which is regulated by the Monetary Authority of Singapore and is directed exclusively at institutional investors as defined by the Securities and Futures Act 2001. This advertisement or publication has not been reviewed by the Monetary Authority of Singapore.
  • Australia by Principal Global Investors (Australia) Limited (ABN 45 102 488 068, AFS Licence No. 225385), which is regulated by the Australian Securities and Investments Commission. This document is intended for sophisticated institutional investors only.
  • This document is marketing material and is issued in Switzerland by Principal Global Investors (Switzerland) GmbH.
  • Hong Kong SAR (China) by Principal Asset Management Company (Asia) Limited, which is regulated by the Securities and Futures Commission and is directed exclusively at professional investors as defined by the Securities and Futures Ordinance.
  • Other APAC Countries, this material is issued for institutional investors only (or professional/sophisticated/qualified investors, as such term may apply in local jurisdictions) and is delivered on an individual basis to the recipient and should not be passed on, used by any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation.

Principal Funds, Inc. is distributed by Principal Funds Distributor, Inc.

© 2023 Principal Financial Services, Inc. Principal®, Principal Financial Group®, Principal Asset Management, and Principal and the logomark design are registered trademarks and service marks of Principal Financial Services, Inc., a Principal Financial Group company, in various countries around the world and may be used only with the permission of Principal Financial Services, Inc. Principal Asset ManagementSM is a trade name of Principal Global Investors, LLC. Principal Real Estate is a trade name of Principal Real Estate Investors, LLC, an affiliate of Principal Global Investors.

MM13500 | 05/2023 | 2919262-123123
About the author