Analysis: Banking crisis scars struggling U.S. real estate stocks

Vornado Realty Trust

19/04/2023 06:00

By Lewis Krauskopf
       NEW YORK, April 19 (Reuters) - U.S. real estate stocks
are struggling this year after a rough 2022, as fears that banks
will tighten lending standards pile pressure on a sector already
hit by higher interest rates.
    After slumping 28% last year, the S&P 500 real estate sector
 .SPLRCR  has gained about 1% in 2023, lagging an 8% rise for
the overall S&P 500  .SPX . Real estate is the only one of the
11 S&P 500 sectors to underperform the benchmark index in both
2022 and so far in 2023.
    Driving this year’s struggles are fears that tumult in the
banking sector following the collapse of Silicon Valley Bank in
March will make it more difficult for real estate companies to
access debt, as banks become more stringent on lending. The real
estate sector has slumped 2% since SVB's troubles came to light
on March 8, compared to a 4% rise for the S&P 500.
    “There is nothing about the current banking situation ...
that made life easier for real estate companies,” said Peter
Tuz, president of Chase Investment Counsel. Because banks have
lost deposits, “they will be just more careful who they lend
money to,” he said. 
    With the S&P 500 real estate sector off nearly 30% from its
all-time high at the end of 2021, investors are looking to
upcoming earnings to determine the sector's near-term
trajectory. S&P 500 real estate company earnings are expected to
fall 0.3% this year after rising almost 11% in 2022, according
to Refinitiv IBES.
    The companies must deliver on their earnings forecasts if
they want to reassure investors, said Wes Golladay, an equity
analyst at R.W. Baird. 
    “They just recently provided guidance with their fourth
quarter earnings and they have to deliver that,” he said.
    Investors are also closely watching office demand, as some
of the largest U.S. banks single out commercial real estate as
an area of growing concern, partly due to a surge in remote
working since the COVID-19 pandemic.
    The S&P 1500 office REITs index  .SPCOMORE  is down 16% over
since March 8 and some individual stocks have seen sharper
declines, with shares of SL Green Realty  SLG.N  down 26% and
Vornado Realty  VNO.N  off 19%.
    “While the market has clearly priced in a lot of negativity
for office REITs, rising delinquency rates and the upward
trajectory of vacancy rates implies there could be more downside
risk ahead,” wrote LPL Financial’s Adam Turnquist in a note
earlier this week. 
    Another key factor is likely to be the future path of
interest rates, investors said. Steady future cash flows from
commercial buildings become less attractive as rates rise, and
real estate stocks were among the worst hit by the Fed’s
aggressive rate increases of 2022. 
    Valuation for a group of over 130 real estate stocks --
comparing stock prices to funds from operations, a common
industry metric -- fell from 25.5 times earnings at the start of
2022 to 17 times by year end, according to R.W. Baird.
        Investors are pricing in 
    another rate increase
     at the Fed's monetary policy meeting next month, with rates
then starting to fall after the summer. The Fed, on the other
hand, has projected rates will remain around current levels for
the rest of 2023. 
  
    Still, some investors believe the selloff may have created
opportunities to buy on the cheap.
    Greg Kuhl, portfolio manager on the global property equities
team at Janus Henderson, said most publicly traded real estate
companies still have sufficient access to capital if they
require it, despite last month's banking issues.
    Kuhn's portfolio is overweight industrial real estate
companies, including shares of warehouse company Prologis
 PLD.N , an area of the market where he says occupancy rates are
comparatively high. 
    "We think the fundamentals are really strong there,” he
said. 
    Indeed, while vacancy rates have gone up in office space
compared to before the coronavirus pandemic hit in 2020, they
have fallen over that time in areas such as retail and
industrial real estate, according to Glenmede.
    The firm currently maintains its weighting in the real
estate sector at a level that it has held in previous years,
said Michael Reynolds, vice president of investment strategy at
Glenmede.
    "People have been blindly divesting from REITs because of
fears on offices, thinking that what is going on in offices is
indicative of the overall space," Reynolds said. "We tend to
think that that’s not the case."

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 (Reporting by Lewis Krauskopf; Editing by Ira Iosebashvili and
Deepa Babington)
 ((lewis.krauskopf@thomsonreuters.com; 646-223-6082; Reuters
Messaging: lewis.krauskopf.thomsonreuters.com@reuters.net,
Twitter: @LKrauskopf))