REIT Risk Skyrockets | Seeking Alpha
The REIT Narrative
REITs are often thought to be ‘safe’ investments, i.e. safe compared to other equity sectors, only behind utilities. REIT revenues and cash flows are supported by leases, which increase visibility of future revenues and decrease volatility in operating fundamentals. REITs are required to pay out 90% of their taxable income. Investors, especially retail investors, prize the dependable dividends.
Putting Numbers To The Narrative
In order to compare the riskiness of the REIT equity sector to other equity sectors, we need a measurement tool. We will bring the statistical concept of beta into the conversation. Beta measures market risk, and the market as a whole has a beta equal to 1. We are using the S&P 500 as the market. We are further breaking the S&P 500 down into 11 sectors to analyze the level of market risk for each sector. The following highlights the five-year beta (2014-2019) of each equity sector and the goodness of fit (R^2). Indeed, entering 2020 with a beta of 0.58 REITs had the second lowest level of market risk (beta) only behind utilities:
There are 31 REITs in the S&P Real Estate sector.
REIT Sector Underperforms
The REIT beta of 0.58 suggests that REITs would decline far less than the market as a whole. However, that has hardly been the case this year as the coronavirus pandemic has rattled REIT investors. We will now reference the Vanguard Real Estate ETF (VNQ) as a proxy for the REIT sector. VNQ holds approximately 185 REITs. By March 23, the ETF had declined by 38% compared to the 30% decline by the S&P 500 Index. REITs and the S&P 500 have since bounced back and the year-to-date losses are over 14% for the VNQ ETF and 13% for the S&P 500 Index:
The REIT Beta Jump
REITs didn’t lose a fraction of what the market lost as expected from the above beta model, but lost more. What happened to the low beta? Year-to-date the REIT sector had a massive beta jump. The REIT sector now has the highest beta of all sectors at 1.44, a beta jump (increase) of 0.85 from the previous 0.58. The only sector with a higher jump was utilities:
Mr. Market now views REITs as the riskiest sector of all.
Why Did The Beta Jump
Consider the attractive qualities of REITs:
- Visibility into revenues via operating leases
- Low volatility of operating fundamentals
- Predictable cash flows
- Dependable dividends to investors
This has all been challenged now:
- Lower visibility into revenues with some firms, like The Cheescake Factory (CAKE), publicly announcing that they will stop paying rent
- Stores are closed and some/most tenants have lost up to 100% of revenue
- Tenants will seek a rent reduction or rent deferment
- Operating fundamentals will be more volatile
- Cash flows will now be unpredictable
- Dividends have become much riskier, dividend cuts are probable
Have Safe REITs Become The Riskiest
Arguably, Health Care and Triple-net (freestanding retail) REITs were the stars of the Great Recession. Leading firms like Ventas (VTR) and Realty Income (O) emerged without having to cut the dividend. However, every Black Swan is different, and these sectors now appear to be two of the riskiest.
The Health Care REIT sector has been suffering from poor supply/demand fundamentals for several years leading into a health care Black Swan event.
Triple-net REITS benefit from long-term leases with visible revenues, and drive returns higher by placing an appropriate (is it?) level of leverage in the capital structure. Revenue visibility has substantially decreased with many tenants effectively closed for business.
The uncertainty surrounding these two sectors can be highlighted in two ways:
- Year-to-date performance
- Beta jumps
Year-to-date these two typically defensive sectors have underperformed the S&P 500 and the Vanguard Real Estate ETF (VNQ) by a wide margin. BINASTNV Index represents Single-Tenant REITs, and BIHLCRNP Index represents Health Care REITs:
Noting that Betas over short time periods have larger errors, we think it is still instructive to examine them. We are comparing year-to-date 2020 through April 9, with the same time period during 2019, to see the change in each sub-sectors beta. The 2019 Beta’s appear abnormally low, even for this low beta sector, which typically runs around 0.4. The 2020 betas have made an enormous jump from the 2019 levels:
|Sub-Sector||Ticker||YTD 2020 Beta||YTD 2019 Beta|
(Source: Author estimates, Bloomberg)
The narrative surrounding REITs is one of low risk and dependable dividends. The low risk can be quantified in terms of beta and has been true, at lease during the last five calendar years. However, REITs have underperformed during 2020 and the uncertainty related to the Coronavirus Black Swan has caused a REIT beta jump. Mr. Market has spoken, and he now considers REITs to be the riskiest equity sector of all. Further, the typically defensive sub-sectors of Health Care and Triple-nets have underperformed both the S&P 500 and a REIT Index ETF (VNQ), and have had their own beta jumps. Time will tell if Mr. Market is right or wrong. If he is right, there could be a barrage of dividend cuts on deck. If he is wrong, this could prove to be a tremendous buying opportunity as REIT betas revert to average levels.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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