Looking Ahead: REIT Valuations Signal Lower Private Asset Values Are Coming

In a recent analysis by CBRE, one conclusion reached was that equity market ups and downs had a bigger influence on short-term REIT performance than underlying real estate fundamentals. The large differences at times between private and public real estate performance or total returns are said to disappear, however, when looked at after a longer-term, four-year period.

CBRE notes that many investors use REITs to gain or enhance their exposure to property without purchasing the underlying asset. Over a short period, the REITs may reflect the volatility of the overall securities market rather than the steadier, income-driven performance of private equity real estate. As a result, investors usually hold their REITSs for several years to gain returns that better resemble private CRE.

But another question looms. Does this trend mean that REIT prices are a weak signal for private equity real estate values—or not? Data compiled by CBRE shows that quarterly Nareit implied cap rates are more stable than total returns and MSCI-RCA transaction cap rates.

Usually, REIT and private-market cap rates then align over time and in that four-year window, but in times of what the report calls “persistent disconnect” they send a key pricing signal. For example, in 2008-2009 when the Great Recession occurred, private deal transactions came to an abrupt halt but public investors “aggressively discounted” REIT asset values, which were reflected in private market-cap rates.

A similar scenario is happening again. Transaction activity is down because of wide bid-ask spreads.  REIT implied cap rates have increased, especially for office space, reflected in steep discounts to net asset value. A few distressed office asset sales offer the possibility that a change is coming: namely a private market devaluation.