Why equity real estate investment trusts should be part of your investment portfolio despite the office sector’s struggles.
Topics covered include:
- Why some office REITs are down 30% in 2023, and owners are walking away from buildings
- How commercial mortgages differ from residential mortgages
- The broad sector diversification found within equity REIT ETFs
- What have equity REITs performed long-term, and what drove those returns
- What is a reasonable return expectation for equity REITs
- Why equity REIT prices adjust more quickly than private real estate values
- Why you should be wary of private REITs
Show Notes
Slow Return to Work Pummels Office Stocks by Peter Grant—The Wall Street Journal
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Transcript
Welcome to Money for the Rest of Us. This is a personal finance show on money, how it works, how to invest it, and how to live without worrying about it. I’m your host, David Stein. Today is episode 434. It’s titled, “Don’t Be Afraid to Invest in Commercial Real Estate.”
One of the things we’ve been focusing on at Money for the Rest of Us over the past few years is how can we make investing simpler? How can we understand the underlying principles, the drivers of performance, the basics of the economy, and how these different elements connect together so that we don’t get caught up in the latest bad news, causing fear and causing us to want to run away or exit or sell a specific investment?
Commercial Real Estate Office Sector
For example, here is a recent Wall Street Journal headline, “Slow Return to Work Pummels Office Stocks.” It’s an article by Peter Grant. He writes “Share prices for some of the largest office landlords have dropped to near historic lows, reflecting a sluggish return to office rate, and a rise in the number of investors betting that these stocks will keep falling.”
It gives some examples of two publicly-traded equity real estate investment trusts. One is SL Green, whose stock is about $22.50 per share, down from $140 back in 2015. Vornado Realty Trust is another REIT that owns office buildings in San Francisco, Chicago, and New York. It’s priced at $13.13 per share, down from $67 per share in 2020. Both of those two public equity REITs are down 30% year-to-date.
Vornado chief executive Steven Roth said on the first quarter earnings call, “We’ve all seen office stocks be crushed in a great concern about the future viability of the office. If we look at occupancy rates or the percent of employees working in offices, it has stalled at roughly 50%.”
More bad news for the office sector. I mentioned this a few episodes ago—I think it was a Plus episode for Plus members—that Brookfield defaulted on $784 million of loans for two Los Angeles office buildings and walked away.
Blackstone Group has a 26-storey building in Manhattan, 1740 Broadway, between 55th and 56th Street. It bought that building in 2014 from Vornado, that equity REIT, for $605 million, at the top of the market. I saw one report that the cash flow for this building doesn’t even cover the mortgage payment and that Blackstone is going to have to put more equity in that building, more capital to keep it operating, or they’ll walk away.
Now, maybe you own some equity REITs. Maybe it’s the Vanguard Real Estate ETF or the iShares Core US REIT ETF, and you suffered through a 25% decline last year, and you see a report like this and you say, “We’ve gotta get out of here.”
Commercial Real Estate Mortgages
It isn’t that bad, really. But before I tell you why, let’s look at some more potentially bad news. If we look at the four and a half trillion dollars that makes up the commercial real estate mortgage market, about 38% is owned by banks; life insurance companies have about 15% of those mortgages, and then another sector, 14%, is commercial mortgage-backed securities, which are a type of security that owns mortgages. Or like residential mortgage-backed securities, except they own commercial mortgages. The loans are sold off, securitized, and packaged into a bond.
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