US REITs underperformed the broad market significantly in December, for the third consecutive month. So, it was the 17th time of weaker dynamics vs the broad market over the last 23 months. On an absolute basis, US REITs ended the month deeply in the red, but just for the second time over the last 8 months or for the 4th time over the last 14 months.
EXECUTIVE SUMMARY
US REITs underperformed the broad market significantly in December, for the third consecutive month. So, it was the 17th time of weaker dynamics vs the broad market over the last 23 months. On an absolute basis, US REITs ended the month deeply in the red, but just for the second time over the last 8 months or for the 4th time over the last 14 months. Thus, the BBREIT index tumbled by 8.8% MoM in December vs -2.5% MoM of the SPX index. The absolute December performance was -1.7 std from the mean monthly performance, and it was in the bottom 4% of absolute monthly performance in the index history. In turn, the relative December performance was -6.5% MoM. It was -1.4 std from the mean monthly performance, and it was in the bottom 7% of relative performance vs the SPX index since the BBREIT index inception. Moreover, the first decade of January wasn’t strong for US REITs either. So, the industry’s index decreased by 0.7% yoy vs +23.3% yoy of the SPX index in 2024. So, the BBREIT index underperformed on a relative basis again in 2024, for the third consecutive year or for the 8th time over the last 9 years, recording -1.0 std from the mean in 2024. US REITs remained volatile in 2024, but the volatility decreased notably in 4Q24, despite an impact of the 3Q24 earnings season as well as uncertainty of Trump’s election victory implications on the sector. Nonetheless, all key CRE segments were in the red in December. So, the difference of monthly price changes of the best and the worst performers among top 50 REITs from the BBREIT index decreased slightly, falling 3.7 p.p. MoM to 15.0% in December.
As a result of still weak both absolute and relative performance yoy, valuations of US REITs remained depressed even despite a notable reverse movement in recent months. Relative valuations vs the SPX index even softened on a yoy basis, staying near the lowest levels over more than 20 years. In turn, absolute valuations don’t look cheap at all vs historical averages, given still elevated rates, much higher on a yoy basis in the recent months. Thus, P/B of the BBREIT index was 2.39x as of January 14, 2025, +0.27 std from the mean since April 2002, and +0.14x since the end of June 2024. P/Sales of the BBREIT index increased by 0.2x from the end of June 2024 to 6.23x as of January 14, 2025 vs the average since May 2002 of 5.6x. In turn, the discount to the SPX index on P/B was 53% as of January 14, 2025 vs the average discount since 2002 of just 22%, -1.9 std. As for P/Sales, the current premium to the SPX index was 108% vs the average premium of 218%, -1.7 std. On P/FFO basis, the median figure of REITs was 16.9x as of January 14, 2025 vs the historical average of 17.9x, or -0.3 std. In turn, median dividend yield of 50 largest BBREIT index members was 4.13% as of January 14, 2025 vs the historical average of 4.04%, or -0.1 std. On EV/EBITDA basis, the median figure of REITs was 19.2x as of January 14, 2025 vs the historical average of 19.8x, or -0.2 std, which is quite consistent with still relatively low financial risks of majority companies in the segment. As for individual names, multipliers are still quite different, but the dispersion across US REITs has decreased significantly in the recent 2 years. Thus, median P/FFO estimates for the office segment were 10.3x/10.5x for FY24/25 as of January 14, 2025 vs industrial segment’s ratios of 18.3x/16.8x.
US economic outlook continues improving recently, but the other side of the coin is higher for longer rates. Thus, the majority of macro data revealed in 2025 were better than expected, especially the last employment report. Moreover, the labor market, which was a key source of uncertainty at the turn of 3Q/4Q of 2024, continues demonstrating signs of stabilizing with strong data across the board in the last two months of 2024. Thus, payrolls increased by 256K in December vs the consensus of 165K (and the revised down November figure of +212K). So, average payrolls in 2024 year were solid 185K vs the average in 2023 year of 251K (289K for 1H23), still remaining notably above the average payrolls of the past cycle. In turn, according to the household survey, total employment soared by 478K MoM in December vs -273K in November, delivering only the first gain over the last three months. On the other hand, JOLTs vacancies increased by 259K to 8.1 mln in November, posting only the 5th growth in 2024, but beating the consensus by 358K. However, the ratio of job openings to unemployed workers has already turned below pre-pandemic levels, staying at just 1.13x in November, still near the lowest figure over more than 6 years. Given some deceleration of the disinflation process in the U.S. in recent months, stabilization of the labor market means lack of monetary easing in the near term. At least, the minutes of the last Fed meeting indicate that many participants of the board are now ready to wait and see, at least for some time, after cutting FF rate by 100 bps in 2024. Unsurprisingly, the much stronger job report caused another round of growth of interest rate expectations. So, it is already expected that there will be just one rate cut in 2025, implying ongoing high pressure of interest rates on CRE fundamentals. In turn, GDP growth will be around 2% in the forthcoming years, notably lower than a post-pandemic average but still quite solid growth rate, given the current level of interest rates. So, it is still expected that recession probability remains quite low, currently staying at just 25%.
2025 will be another difficult year for CRE, but gradual improvement of fundamentals will continue. At least, we don’t expect that it will be as challenging one as three previous years, when US REITs underperformed the broad market significantly. It doesn’t necessarily mean that it will be an inflection year from a relative performance point of view, but we believe that emerging improvement of both REITs’ and underlying market fundamentals will continue in the nearest years, even despite still elevated rates. Nonetheless, the correlation between average monthly 10yr treasury yield and the BBREIT index still remained quite strong, at -0.83 since the beginning of 2022. However, it weakened slightly in the last months. Moreover, the benefits of Trump’s changes to the US economic policy still look rather mixed for the sector. Given a tax-exempt nature of REITs’ business, lower taxes will impact their fundamentals only through faster economic recovery, which, in turn, may suffer from higher rates caused by the same faster GDP growth and elevated inflation. Moreover, changes to tariffs and immigration policy look rather negative risks for the majority of CRE segments. Of note, the BBREIT index underperformed the SPX index by 12.6% in 2017, the first year of Trump’s previous presidency, when a notable decline of corporate tax rate was announced. On the other hand, the underlying property market has almost found its equilibrium in recent months. Indeed, CPPI decreased just by 0.5% on a yoy basis in November, remaining roughly flat during the last 1.5 year with positive second derivative in all key CRE segments. Moreover, transaction volumes have bottomed out either, but still remaining at depressed levels. Hence, it is expected that REITs’ NOI growth will continue to be at healthy level of 3%+ yoy in 2025 with positive NOI growth even in the office segment. It will be accompanied by lower vacancy ratios, higher absorptions and gradual acceleration of rent growth, which, among other things, imply further acceleration of FFO growth. Nonetheless, we still expect a bumpy road ahead, at least in the nearest quarters, because of significant growth of interest rate expectations during the last months. Of course, balance sheets of majority REITs still remain strong even after quite challenging 2024, but higher for longer interest rates imply that debt coverage ratios will continue deteriorating relatively fast. Taking into account current valuations as well as gradual acceleration of FFO growth, we won't be surprised at all to see a certain re-rating of US REITs. But given still high risks, we don’t expect any significant outperformance of the sector near term. So, we still remain neutral on the sector.
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