Industrial REIT Returns Plunge as Uncertainty Overtakes Market

The REIT rebound in March is now a distant memory as most REIT sectors stayed in the red for the second month a row in May, according to data from S&P Global. Most REITs now have been in negative territory for four of the first five months of the year.

In what may be the shape of things to come, the industrial sector notched the steepest monthly decline among REIT categories in May, with the 13 industrial REITs posting an average negative return of 15.6% as investors process Amazon’s sudden reversal of its logistics network expansion.

Year-to-date returns for industrial REITs are now 22.7% below the record yields achieved in 2021, when demand for industrial space skyrocketed as e-commerce surged during the pandemic. The only REIT sector faring worse in 2022 YTD comparisons is the mall sector, down 27.5%.

Mortgage and infrastructure REITs were the lone bright spots among average returns for May; mortgage REITs (also known as mREITs) specializing in home financing posted 5% average yields, while infrastructure REITs, led by trusts specializing in cell tower, reported yields averaging 3.3%.

Mortgage REITs specializing in commercial financing also reported positive gains averaging 2.1%. Health care REITs kept their heads above water in May with average yields of 1.3%.

A consistent stand-out in dividend growth among mREITs has been Arbor Realty Trust, which earlier this year delivered its 10th straight year of dividend growth in a sector where many of its rivals have reduced their dividends in recent years.

According to an analysis earlier this month, The Motley Fool said the secret to Arbor Realty’s success has been a business model that insulates the mREIT from the impact of changing mortgage rates. 

Most mREITs buy long-duration debt that they finance with short-term borrowings to take advantage of the spread between long- and short-term interest rates, the analysis said. In periods of volatility, this net interest margin can contract, causing these REITs to suspend or reduce their dividend.

Arbor Realty deploys a “balance sheet” strategy that focuses on using long-term debt to fund loans it originates, mitigating the impact of changing rates on its net interest margin, the Motley Fool analysts said. 

Arbor’s focus on originating loans instead of buying them from other lenders enables the REIT to earn high-margin loan origination fees, especially on loans it sells to government agencies. Arbor also generates recurring income streams from servicing the loans it holds and sells.

According to the Motley Fool analysis, Arbor originated $2.83B of loans during the first quarter, growing its portfolio by 17%; it now directly holds $14.2B of debt, yielding 4.38%, up from $12.2B yielding 4.26% since the beginning of the year. 

Arbor’s fee-based servicing portfolio is now approaching $27B. The mREIT focuses on funding the multifamily sector.