Forecast Offers 'Guarded Optimism' for REITs

Concern, caution, conservatism and guarded optimism marked a June report from Mizuho Securities USA following the first-of-its-kind, virtual NAREIT conference.

The national association of real estate investment trusts held Zoom and Webex calls with companies that own or finance income-producing real estate across a range of property sectors. The report that followed tackled the question of validity of a growing optimism about REITs in the post COVID economy.

The coronavirus pandemic and the disease it’s causing, COVID-19 — has “left chaos in its wake,” Mizuho’s own Michal Katz, head of the banking division, said in an article on the financial company’s website. “Few events in the past century have so disrupted human society. Fewer still have done so as quickly.”

Katz added that “Every aspect of our lives has been affected. Over the past six months, entire nations have been locked down, industries mothballed and global supply chains have been disrupted as we have struggled to keep up. Many questions surround the virus and its impact remain unanswered, but one thing is clear – the ‘new normal’ will look quite different in every aspect of our lives: society, culture, economy and government.”

While no sector of the economy has been untouched, some have fared better than others, according to Katz and the report on the NAREIT Zoom meeting.

“The conference was informative, though devoid of big surprises,” Mizuho reported. “Rent collection risk and the perceived post-COVID outlook for specific sectors and/or stocks continues to be the driver of performance, respectively, with focus also on dividend safety and balance sheets.”

In general, May rent collection wasn’t materially different from April across most sectors, Mizuho reported. “Looking ahead, most management teams expressed guarded optimism” about the economic and operating outlook as the economy re-opens slowly and the COVID-19 pandemic eases to some extent, the report said.

Mizuho Securities USA is part of Misuho Financial Group, which came together in late 2002, merging three of the largest banks in Japan. The company reported $1.8 trillion in assets as of December 31, 2018. The NAREIT report broke down its analysis by market sectors.

Apartments.

Rent collections remain high, the company reported. “But we’ve grown more concerned about near-term prospects given rising unemployment rolls, urban flight risk (for affordability, space and safety) and sizable upcoming lease maturities in mid-year peak leasing season against weaker demand,” the report said.

The trends observed from NAREIT meetings and early second quarter portfolio trends “reinforced our fears as new lease rates continued to decelerate in May,” the report said. The concerns were especially concentrated on the coasts. Delinquencies generally up as well.

“Improved traffic trends are encouraging,” the company said. “Steadier renewal rates, lower turnover and technology benefits should help, but won’t be enough. We favor names with greater geographic/price-point diversification.”

Healthcare.

The company said its forecasters remain positive on skilled nursing facilities and medical office buildings, but not so much on senior housing. Government aid is providing skilled nursing facilities with cash to meet rent obligations. Medical office buildings “are beginning to see demand pick up as local economies re-open, so it appears business could bounce back relatively quickly.” But senior housing remains challenged as occupancy declines and expenses increase with no federal aid yet.

“We worry that senior housing rent coverage ratios are not sustainable if the situation does not improve soon,” Mizuho said. Look for senior housing operating portfolios to post some of the worst growth figures “we have ever seen” in the second quarter of 2020.

Industrial.

E-commerce has grown during the pandemic, driving up demand for “last mile” industrial space, the report said. However, bad debt is a risk for those with smaller tenants.

Office.

Mizuho predicts an evolution in demand as the work-from-home trend in the pandemic continues. The question will be whether that shift puts a dent in space needs for companies going forward. Long commutes combined with high rents “do not bode well,” the report said. “We suspect regional offices may come back into vogue.”

Strip Centers.

“Uncertainty reigns” for the commercial shopping strip center category, based on the limited amount of information available from the gathering. “Malls were a no-show,” the report said, referring to the participants in the gathering. Strip centers “remain uncertain on the near-term rent collections outlook and operating conditions,” the report said. “This lack of clarity (disruption duration, depth of cash flow declines, dividend implications) makes it difficult to own the sector for fundamental reasons near-term, despite the material stock price declines,” the report said.

Singlefamily rental properties.

“We are incrementally optimistic,” the report said. Single family residential real estate is still a good value “relative to historical multiples.” Mizuho’s estimates for single family rentals went up slightly after meeting with companies in that area.

Triple Net.

“We remain concerned given still-modest rent collection rates,” the report said of tenant pays all expenses leasing. “Managements were notably optimistic for June and July as rent collections in most corners of its portfolios” — such as theaters and fitness centers — “remain solid or are improving as more states re-open.”

“It would be cliché to note the unprecedented ripple effects COVID-19 will have going forward if it were not simply the truth,” Katz concluded. “Social rituals will be suspended, economic patterns will be altered and political systems reordered. But amid all of this, if we use history and data as our guide, it will shed some light on our path forward to allow us to find our footing in this new normal.”