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REITs showing their backbone as economy works to recover

By Michael Siino

As with each subsector under the umbrella of real estate, the effect of the COVID-19 pandemic on Real Estate Investment Trusts (REITs) has been varied, creating opportunities and challenges that seem likely to continue throughout the year ahead.

Within the various property sectors owned by REITs, performance has reflected the current conditions of those sectors in general. In sectors such as hospitality, retail and office, all heavily affected by social distancing and shutdowns, REIT performance has suffered. However, these sectors represent less than one-third of the REIT industry.

For the remaining two-thirds, performance has been at times substantially better, as the effect of social distancing has not been as severe.

An in-depth look at the structure of REITs and the performance of the broader real estate market is needed to determine how REITs are positioned for recovery.

One key factor allowing REITs to perform effectively over time is their ability to diversify. In whatever sector they are focused, REITs benefit from the opportunity to gain access to favorable financing through pooled investments, and by including properties across geographic regions so as to avoid the effects of micro-economic conditions.

While the effects of this pandemic have not left any geographic area unscathed, prior to COVID-19, overall leverage ratios on REITs were at historic lows. Because of this, and because they have been able to strengthen their overall financial positions over time, REITs have been able to withstand many of the harshest impacts felt by so many industries during the COVID-19 crisis.

REITs were well prepared to respond to changing economies and downturns created by any number of external factors, including the pandemic.

That is not to say that the changing landscape within the real estate industry will not have a lasting effect on REITs.

Businesses are reconsidering whether it remains necessary to work from traditional office locations to the same degree as they had in the past, and the success of remote work has surpassed even the most optimistic projections. It is likely that flexible work arrangements, shared spaces and video conferences will continue to find a place in the new office environment. A reduction in daily staff population may be offset by allowing for a larger footprint per employee, in case another public health crisis arises and social distancing is required. These unknowns make it increasingly necessary for owners and landlords to adapt.

“As long-term leases expire and new leases are written, creatively addressing tenants’ concerns and adding flexibility to lease terms could allow for recovery of the office sector and of those REITs associated with it.”

As long-term leases expire and new leases are written, creatively addressing tenants’ concerns and adding flexibility to lease terms could allow for recovery of the office sector and of those REITs associated with it.

If businesses in industries hit hardest by the pandemic continue to experience significant downturns and are forced to shutter, tenants will continue vacating commercial spaces, and the likelihood of this excess available space being reinhabited remains difficult to anticipate. The impact on the commercial real estate industry will affect REITs as well. However, whereas hotel and hospitality REITs have suffered and are expected to continue struggling until business and vacation travel regain momentum, other sectors such as industrial REITs have fared far better, due in large part to the predominance of long-term leases with contractual increases.

Retail REITs remain challenged as the move towards online shopping continues to accelerate. As it relates to REITs focused in the single family housing and data center sectors, NAREIT reports that demand has increased, which will lead to recovery and growth in those sectors.

Overall, the attractiveness of REIT investments remains intact—REITs can provide short-term and regular dividends, as well as long-term capital appreciation.

They are managed with the goal of maximizing shareholder value, by positioning their assets in such ways as to improve value in the short-term as well as over time. REITs have performed well when compared to similar indexes, and often offer significantly higher value than many other classes of investment.

 While it is difficult to make a general assumption on the recovery of REITs as a whole, a closer look at the individual sectors within real estate and the REIT market reveals varying challenges and prospects for short- or long-term recovery.

While REITs have not been immune to the pervasive effect that the pandemic has had on the economy and on the real estate industry, the level of impact and the prospects for impending recovery depend on the sub-sector within which they are focused.

Today’s low interest rate environment has helped to soften the impact of the crisis and will likely aid in the recovery across all sectors, as debt becomes due and refinances can be done on favorable terms.

While the economy and the real estate industry continue to fluctuate, investors may take a more selective approach to which sector they invest in and into which REIT they put their trust, but the recovery of REITs will continue to reflect the strength and resilience of the real estate market as a whole.

Michael Siino, CPA, is the Co-Partner-in-Charge of the Real Estate Group at Marks Paneth LLP.

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