In 2009, prior to becoming a REIT analyst, I was a real estate developer. This means that I was working in the trenches trying to develop sites for companies like CVS, Dollar General and Advance Auto Parts. It wasn’t easy to grasp the impact of the financial crisis, until I began to see a record number of banks closing. As a developer, you rely on banks to keep the business going, and when the access to capital dried up, so did my job.
Fast forward ten years and I can now fully comprehend the impact of the Great Recession. I remember when Lehman Brothers filed bankruptcy in 2008 and then the dominoes began to fall. Most of my net worth back then was tied to private real estate, and for many (including me), retirement had to be extended and many workers (including me) were forced to reinvent themselves. The long-term impact on retirement portfolios varied, but for those who stuck it out, many have been rewarded. But there have certainly been lessons learned.
As I reflect on the dark days, I am reminded of the following observations:
Debt Can Be Dangerous: Many REITs that were forced to cut dividends in 2008 and 2009 were considerably debt heavy. However, since 2010 REITs have raised more than $300 billion in total equity capital, validating the strength of the financial markets. Also, during that time, REITs have made prudent use of debt, which has accounted for less than half the total capital raised. As a result, the ratio of total shareholders’ equity to book assets has risen to 44.5%, more than 12 percentage points higher than a decade ago. Well-capitalized balance sheets have also reduced REITs’ exposures to interest rate movements.
The limited use of debt to finance acquisitions in recent years, combined with the low level of market interest rates, has pushed interest expense as a share of net operating income to the lowest on record. In short, REITs have well-capitalized balance sheets that give them a sound financial position to take advantage of investment opportunities that may arise in the years ahead, while also providing a solid cushion against rising interest rates or any unexpected future market developments.
Diversification Can Be Powerful: As a real estate developer in 2008, I had very little diversification. Most of my assets were held in private partnerships and I was not the manager, which means that I had little control of the operations of the company. When the financial markets soured, there was no real liquidity and as a result I had to write off loans and my net worth tanked. Investors who diversify their portfolios have historically had a better chance of ending up with higher returns because diversification reduces portfolio volatility and mitigates losses from any one security or asset class.
More specifically, listed REITs help to diversify a portfolio because, as real estate, they are a distinct asset class that has demonstrated low-to-moderate correlation with other sectors of the stock market, as well as bonds and other assets. In other words, REIT returns have tended to zig while returns of other assets have zagged, smoothing a diversified portfolio’s overall volatility.