REITs as a Hedge Against Inflation

Scott Pickett

REITs suffered during the first half of 2022. Despite record earnings and strong balance sheets, stock prices  declined. The Federal Reserve’s actions have created uncertainty in the markets and could have further negative impact on valuations in 2023.

During the second half of the 2022 and the beginning of 2023, we expect to see cap rates rise following interest rates, putting further downward pressure on real estate pricing. Buyer and seller’s expectations are currently not aligned, and that has resulted in a significant drop in transactions. The second quarter of 2022 saw nearly 50 percent decline in volume compared to the second quarter of 2021.

If the Federal Reserve continues to raise rates, this will continue to negatively affect REIT share prices. Once the Federal Reserve sees inflation declining, they should slow further rate increases and the markets should equalize.

Another trend we’re seeing currently is smaller REITs becoming acquisition targets for other larger REITS and private companies. Further consolidation of the industry through merger and acquisitions creates further economies of scale and savings in accounting and administrative expenses. Prologis completed its acquisition of Duke Realty for $23 billion. This follows its acquisitions of Liberty Property Trust and DCT Industrial in 2020. Blackstone has also been on a buying spree this year acquiring American Campus Communities, PS Business Parks, Preferred Apartment Communities, and Resource REIT. This trend will most likely continue as lower valuations create opportunity for well capitalized firms.

Mixed Results

We expect to see continued pressure on office REITs as long lasting effects from the pandemic affect how people and businesses use commercial real estate.

Apartment REITs had a great year in 2021 outperforming every product type thanks to rising rental rates and relatively short-term leases. Another positive trend is lodging and resort REITs moved closer to pre-pandemic revenues in June and July of 2022.

Retail REITs are making a comeback since the pandemic. This is largely due to increased consumer spending through 2021 and the first half of 2022. This trend may be starting to change in the second half of 2022 and will most likely decline in 2023, especially if the United States falls into a recession.

The REIT markets are in flux. Lower valuations and increased returns, due to the Federal Reserve’s interventions, are creating opportunities for higher dividend yields and possibly longer-term appreciation.

REITs offer investors higher yields than they can get from the US Treasury. In a down market, higher yields could offer additional returns from appreciation of share value as the markets rebound or interest rates are lowered in the future. As rental rates increase from inflation, REITs offer investors higher annual returns from the additional income. These higher returns come with more risk than investing in treasuries but may be an attractive way to hedge against inflation.

Scott Pickett is managing director of Avison Young’s Columbus office.