Recover And Rebuild: A Decade In Review

Summary

• "Recover and Rebuild." Despite entering the decade scarred and wounded from the financial crisis, REITs and Homebuilders delivered strong and steady performance throughout the 2010s.
• Limited supply and swelling demand defined the decade for most major property sectors, while other sectors saw significant upheaval - some positively and others negatively - by technological disruption.
• Since the start of 2010, REITs produced a compound annual return of 12.6%, slightly shy of the 13.5% compound annual return on the S&P 500. Homebuilders gained 18.5% per year.
• At the real estate sector-level, three themes dominated the 2010s: 1) The Housing Shortage, 2) The Retail Apocalypse, and 3) The Internet Revolution.
• Access to capital became a critical competitive advantage for REITs during the decade, which saw the sector evolve from passive "buy-and-hold" portfolios into dynamic, growth-oriented real estate operators.
• This idea was discussed in more depth with members of my private investing community, iREIT on Alpha. Get started today »

REITs: A Decade In Review

"Recover and Rebuild" was the theme of the 2010s. Despite entering the 2010s scarred and wounded from the devastation of the financial crisis, REITs and Homebuilders delivered generally strong and steady performance throughout the last decade following an intensely volatile 2000s. Limited supply and swelling demand defined the decade for most major property sectors, while other sectors saw significant upheaval - some positively and others negatively - by technological disruption. In this report, we recap the performance and major trends we observed across the US real estate sector over the last ten years.

(Hoya Capital, Co-Produced with Brad Thomas through iREIT on Alpha)

REITs (VNQ), as measured by the FTSE NAREIT All Equity REIT Index, delivered their second-best year of the decade in 2019, delivering a total return of nearly 29%, falling just short the impressive 31% return on the broad-based S&P 500 (SPY), which was also the second-best year for that index of the decade. Since the start of 2010, REITs produced a compound annual return of 12.6%, slightly shy of the 13.5% compound annual return on the S&P 500. Homebuilders (ITB), after losing nearly 80% of their value at the depths of the financial crisis in 2009, emerged as one of the top-performing equity sectors of the decade, delivering annual returns of 18.5%.

At the real estate sector-level, three themes dominated the 2010s: 1) The Housing Shortage, 2) The Retail Apocalypse, and 3) The Internet Revolution. Four of the five best-performing real estate sectors over the decade were on the residential side as the positive tailwinds of the affordable housing shortage continue to provide a favorable macroeconomic backdrop for rental operators and homebuilders. The two worst-performing real estate sectors, on the other hand, were malls and shopping centers, as the so-called "retail apocalypse' continues to take its toll on landlords. Finally, the sector also saw three new property sectors emerge including two "technology REIT" sectors: cell tower and data center sectors, which have ridden the secular tailwinds related to "big data" and cloud computing and have each been top performers since bursting onto the scene around mid-decade.

2019 was a near-perfect encapsulation of trends seen throughout the 2010s. Among REIT sectors, manufactured housing again took home the top spot this year with total returns of 49%, outperforming the REIT sector average for a remarkable eighth straight year. Industrial REITs finished as a close second with total returns of 48.7% for the year, followed by single-family rental, data centers, timber, and cell tower REITs, each with total returns above 40% for the year. It was difficult not to make money in the real estate sector this year, but mall and prison REITs found a way with total return losses of -9.1% and -5.0%, respectively. For mall and shopping center REITs, 2019 marked the fourth consecutive year of underperformance.

For the residential real estate sector, it was a year of rejuvenation following the worst year for the housing sector since the financial crisis, powered by the tailwinds of significantly lower mortgage rates and demographic-driven demand. The Hoya Capital Housing Index climbed by more than 35% on the year on a total return basis, led by a nearly 50% jump from the single-family homebuilders. The "multiplier" effects of recovering home sales and reaccelerating home values have begun to be felt by other housing-related sectors as well with strong performance from the homebuilding products, real estate insurance, and home furnishing sectors.

Taking a step back, limited supply and swelling demand defined the decade for most major property sectors as supply growth came to a standstill in the aftermath of the financial crisis. Lending conditions generally remained tight for new construction projects until the middle of the decade and regulatory barriers to entry continue to restrain supply growth in several sectors even as lending conditions have loosened. Access to capital became a critical competitive advantage for REITs during the decade and allowed these companies to capitalize on the opportunity to become active developers. Before 2005, only a handful of REITs had in-house development teams, but that has changed significantly over the last decade, and half as many large REITs are among the most active real estate developers in the country.

REITs are no longer simply "buy-and-hold" real estate holding companies but have become dynamic real estate operators, developers, and "capital recyclers" over the past two decades. After an understandably slow start to the decade, REITs were able to get back to doing what they do best: utilizing their access to equity capital markets - one of their primary competitive advantages over private market peers - to accretively grow via external acquisitions. REITs acquired more than $660 billion in assets in the 2010s while selling $330 billion in assets, recording net growth of $330 billion in assets.

After 156 REIT IPOs in the 1990s and 71 REIT IPOs in the 2000s, there were 77 REIT IPOs in the 2010s, raising a combined $25 billion in IPO proceeds. The six largest IPOs were Paramount Group (PGRE) in 2014, Invitation Homes (INVH) in 2017, VICI Properties (VICI) in 2018, MGM Growth Properties (MGP) in 2016, Empire State Realty Trust (ESRT) in 2014, and Brixmor Property Group (BRX) in 2013. 2019 saw just 2 IPOs, the slowest year since 2008, headlined by Postal Realty Trust (PSTL) back in May.

Importantly, IPOs remain a relatively small portion of total equity raising for the REIT sector. REITs raised roughly $400 billion in equity through secondary equity offerings in the 2010s including common, preferred, and at-the-market offerings. The increased use of unsecured long-term debt has been perhaps the most important under-the-radar theme of the 2010s as well. Entering the decade, less than two dozen REITs held investment-grade long-term credit ratings. At the end of 2019, more than 80 REITs held investment-grade ratings from at least one of the major ratings agencies. As a result, REITs were able to raise $300 billion in unsecured debt over the last decade, helping to fuel the real estate sector's significant growth over this period.

For 2019, among REITs in our coverage universe, Universal Health Realty (UHT), New Senior Investment Group (SNR), Equinix (EQIX), Terreno (TRNO), and Rexford (REXR) were the top-performing individual REITs. Among large-cap REITs with a market cap of $20 billion or greater, American Tower (AMT), Prologis (PLD), and SBA Communications (SBAC) were the best performers. CBL & Associates (CBL) and Macerich (MAC) were the worst performers, followed by Taubman (TCO), Senior Housing Properties Trust (SNH), Tanger Factory Outlet (SKT), and Washington Prime (WPG). Prison REITs GEO Group (GEO) and CoreCivic (CXW) also finished in negative territory despite strong performance over the last month. Among large-cap REITs, Simon Property (SPG) and Ventas (VTR) were notable laggards on the year as well.

Looking Forward To The 2020s

In a report next week, we'll discuss the major lessons learned from the 2010s and how real estate investors can apply these teachings to hopefully further improve their investment performance in the 2020s. As a preview, one area of focus will be: Sector Selection First, Stock Selection Next.

There's a reason that we dedicate so much time and resources to analyzing (and sharing) our property-level and macro-level sector fundamental analysis: property sector selection is the single most important determinate of performance in real estate investing. Over the last decade, the average year saw a 40% average spread between the best and worst-performing real estate sectors. Importantly, performance within each individual property is highly correlated over the course of any given year, driven primarily by macro-level trends. To give oneself a shot at outperformance, we believe that security selection within the REIT sector must begin with property sector selection.

If you enjoyed this report, be sure to "Follow" our page to stay up to date on the latest developments in the housing and commercial real estate sectors. For an in-depth analysis of all real estate sectors, be sure to check out all of our quarterly reports: Apartments, Homebuilders, Student Housing, Single-Family Rentals, Manufactured Housing, Cell Towers, Healthcare, Industrial, Data Center, Malls, Net Lease, Shopping Centers, Prisons, Hotels, Office, Storage, Timber, and Real Estate Crowdfunding.

Disclosure: I am/we are long INVH, VNQ, SPY, AMT, PLD, EQIX, SPG, TCO. 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.