COVID-19 has been a significant determinant of investment performance since 2020. It is now one of several forces impacting returns on various types of investments, from stocks to REITs. Inflation, interest rates, recessions, energy prices, geopolitical turmoil, and the vicissitudes of the COVID pandemic have whipsawed stocks and REITs during the three-year period.
The Dow Jones Equity All REIT index posted a 41.2% return in 2021, while the S&P 500 finished the year with a return of 28.7%. However, 2022 saw the REIT index drop 28.71% versus the S&P’s loss of 19.44%.
The question is, how much impact did (and does) COVID have on the REIT market? Yonpei Cai and Kuan Xue (C&X) of Dalhousie University in Halifax, Canada, just published a timely paper entitled “Net Impact of COVID-19 on REIT Returns,” comparing COVID’s impact against that of recessions. The authors admitted surprise at their results, which showed COVID had a positive or neutral effect on some REIT sectors despite the brutal hit from the COVID pandemic.
Previous studies showed that US REIT returns derive mainly from the type and geographical distribution of REIT properties. However, these studies didn’t compare the relative impact of COVID with that of recessions upon REITs. As C&X point out, the COVID-triggered recession had some unique features:
- Governments restricted some economic activities and accelerated others. Travel bans, social distancing, work at home, grace periods on rents and foreclosures, and business lockdowns all reduced and delayed rent payments, the source of 75% of REIT gross income.
- Rapid accumulation of knowledge about the virus led to early vaccine development.
- Cooperation is required from the general public for policies that extend beyond normal monetary and fiscal responses.
- Market returns have been volatile, dating from February 2020
- Travel bans were felt keenly by retail, residential, and hospitality REITs.
The study presented findings tied to several REIT sectors. Without going into the complex mathematics, the authors used a model based on the following variables:
- REIT sectors
- REIT companies
- Time periods
- REIT returns minus three-month Treasury bill rates (i.e., REIT excess returns)
- Coefficients for recent recessionary periods
The most significant coefficient measures the net impact of the COVID-19 pandemic on REIT excess returns for each property type. Another important coefficient measures the net effect of recent recessions on REIT excess returns by property type. Combining these two coefficients measures the aggregate impact of the recession induced by COVID-19.
The researchers did not show that COVID created positive returns, only that it helped to cut losses in specific sectors.
A substantial portion of industrial REIT revenues stems from the demand for warehousing and logistical spaces. COVID boosts this demand through movement restrictions that encourage eCommerce and remote work. C&X found that COVID-19 had a positive, statistically significant impact on industrial REIT returns but that recessions had a negative, albeit statistically insignificant effect. Industrial REIT returns fell the least among the four sectors studied during the coronavirus pandemic.
COVID forces employees and executives to take up remote and home work. A survey from Price Waterhouse Coopers found that office workers increasingly tend to rotate in and out of hybrid workplaces. Contrary to expectations, C&X found that COVID-19 positively impacted office REIT returns, statistically significant at the level of 1%.
As expected, the net impact of recessions on office REITs was negative, and the result was statistically significant at the 5% level. Business closures, reduced office utilization, and remote work are all factors that contributed to office REIT losses.
To some extent, COVID offsets the negative impact of recessions on office REITs, perhaps due to existing office leases and percentage rent clauses for commercial properties. The clause requires a commercial space tenant to pay a base rent plus a percentage based on the business owner’s monthly sales volumes. Nonetheless, the most recent recession took a considerable toll on office REIT returns.
COVID worsened the rental crisis as populations sought the supposed safety of the suburbs coupled with the convenience of working from home. In fact, the federal government created the Emergency Rental Assistance Program to ease the financial burden of households unable to pay their rent. One would expect that delays in rental payments would hurt the residential REIT market.
Once again, the researchers uncovered unexpected results regarding the impact of COVID-19, showing that returns were positive at the 1% statistical level. Recessions had a negative effect at the much more stringent 0.1% level. The results did not support the team’s hypothesis that COVID harmed residential REITs but wasn’t strong enough to rule out zero impact.
Many signs point to how badly COVID affected the retail sector, especially brick-and-mortar stores. However, C&X could not disprove that COVID had zero impact on retail REIT returns. Recessions had a negative effect, but the result wasn’t statistically significant. The researchers suggest that retail REIT returns react to the long-term impact of the boom-and-bust cycle rather than recessions in isolation.
Interestingly, the researchers found that retail REIT returns are strongly correlated to inflation, credit conditions, property values, and structural changes due to recessions.
2023 REIT Outlook
The National Association of Real Estate Investment Trusts (Nareit) has looked into its crystal ball and sees better times ahead for REITs, listing these factors:
- REITs have strong balance sheets that should position themselves for 2023’s economic uncertainties.
- REITs currently use historically low amounts of leverage and boast of well-structured and -termed debt.
- By reducing leverage, REITs have lowered expenses relative to net operating income.
- The combination of strong balance sheets and low leverage makes REITs formidable competitors for property purchases.
Fidelity Investments holds out hope for residential rentals in 2023 because “renting is currently much more affordable than buying in many parts of the country.” It also sees REIT prices stabilizing as interest-rate increases slow down.
As for COVID-19, a new, deadly strain will undoubtedly have a negative, perhaps devastating, impact on REITs in 2023. However, the scientific community has developed protocols to create new vaccines quickly and effectively. REITs also must contend with continuing economic uncertainty, inflation, and high interest rates. It appears that REITs have strengthened their ability to withstand exogenous shocks and are a prudent asset class for investors looking to diversify their portfolios.