REITs romped in 2021 as property values soared

Investors who bet on real estate investment trusts at the beginning of 2021 are reaching for top-shelf champagne these days as they prepare to celebrate the new year.

They can afford to splurge. The FTSE NAREIT Equity REITs index was up 36% in 2021, compared with 26% for the S&P 500 as of Dec. 23, according to real estate analytics firm Green Street. If that trend continues for the remainder of the year, 2021 will be the REIT index’s best year since 1976 in terms of absolute performance, Green Street said.

But will the same strategy work again in 2022? Investors who are planning to double down on this year’s REIT strategy might want to hold off for now on buying Dom Pérignon by the case, some analysts warn.

For starters, REIT strength this year was partly a rebound after a bad 2020. With office, retail, and other property types hammered by the pandemic, the sector fell 8% last year compared with an increase of 18.4% for the S&P 500, Green Street said.

Next year it is doubtful this year’s momentum can be maintained. "It’s hard for us to see the group putting in a similar year in 2022," said Steve Sakwa, an analyst with Evercore ISI.

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Meanwhile, dangers are lurking in the REIT sector. Concerns about the omicron variant of the Covid-19 virus already are dampening hopes that millions of people who have been working from home throughout the pandemic will return to offices in January.

REIT shares, like those of numerous other companies, also could face a bumpy ride in 2022 from inflation and rising interest rates. "Headline risk around additional variants, inflation and interest rates will create significant volatility over the next 12 months," said a December report on REITs by Evercore ISI.

A few property types have continued to thrive throughout the pandemic. For example, total returns of industrial REITs have been over 40% since the pandemic hit because of the rise in online retail sales, according to analysts.

Total returns of self-storage landlords have increased more than 80% during that same time frame as people working from home have decluttered, analysts said. "Folks wanted the extra space," said Michael Mueller, an analyst with JPMorgan Chase & Co. "They cleared out the back bedroom."

Meanwhile, REITS that own properties like office buildings, malls, senior housing, and hotels that depend on business travel have been tracking the ups and downs of the pandemic since early 2020. Their stocks have tumbled when new variants have appeared and soared with promising news about vaccines.

"When you think of 2021, everything started with the vaccine news in November 2020," said Cedrik Lachance, Green Street’s head of research.

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Good news about vaccines as 2021 began boosted the performance and share prices of some REITs faster than expected. For example, demand soared in the first half of 2021 for rental apartments in cities like New York and San Francisco that had seen an exodus of renters in 2020.

Shoppers also surprised some analysts by returning to malls so quickly. For example, strong sales helped push the share price of Simon Property Group Inc., the largest mall owner in the U.S. to above $150 a share, which is where it was trading before the pandemic hit.

The rise in inflation, so far, has been good for REITs because it has helped drive up mergers and acquisitions volume, as well as sales volume and values of individual properties. Many investors consider real estate an inflation hedge because owners can raise rents to stay ahead or at least keep pace with rising prices.

"If the cost of building real estate goes up because of inflation, you don’t have the ability to build more supply until rents get to a certain level to justify it," said Tony Paolone, analyst with JPMorgan.

But inflation may be painful for highly leveraged property owners next year if it sparks sharply higher interest rate costs. Inflation and higher rates also could lead to an economic downturn and drops in demand for a range of property types.

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Health news in 2022 will be even more of a wild card for REITs, analysts say. Bad news will likely hurt property types like office and senior housing while helping REITs that specialize in data centers which see strong demand when people are sitting at home streaming movies and TV shows.

Good news will boost malls and hotels. Mr. Lachance, of Green Street, predicted a possible repeat of the "revenge spending and revenge traveling" that has occurred when infection rates have fallen. To get back at the virus, people "hit the mall and buy things because it makes them feel good," he said.