Front & Center Podcast: Episode 85 – Reading between the Earnings Calls: REIT Debrief

00;00;00;00
Intro
Hello and welcome to Front and Center, a show dedicated to insights and perspectives on commercial real estate investment across the public and private markets. For more information, please visit center. Com. Welcome back to another episode of Front and Center. I’m Uma Moriarity, Senior investment strategist and global head of sustainability here at Center Square. We are just wrapping up a couple months of REIT earnings season and conferences.

00;00;18;05
Uma
We’ve been on the road speaking with a lot of CEOs and CFOs and executives. We’re excited to bring some of those conversations to you here today. Joining me are Patrick Wilson and Rob Goldstein, both portfolio managers for our listed real estate platform. So thank you both for joining us today.

00;00;48;05
Patrick & Rob
Pleasure to be here. It’s good to be here.

00;00;50;09
Uma
All right. So Patrick, maybe we’ll start with you and maybe address the elephant in the room. I guess as it relates to investing in real estate these days, the ten year Treasury yield is playing around with 5%, and the reads, surprisingly, have still posted positive returns year to date. What do you think is driving the REIT market? How do you kind of square what’s happening with interest rates and and how you’re thinking about the sector in general?

00;01;15;12
Patrick
Yeah, that’s a great question. I think a lot of people are looking for those answers. I’d start by saying that rights are materially different than they were historically. I don’t think you can view them as a pure rate proxy as you have in the past. And there’s a couple of reasons for that. One context of where we are in the cycle. In typical rate hiking cycles, your the economy’s going gangbusters. Growth is very, very strong. You’re trying to tamp out that we do have some inflation which is common at the end of the cycles as well. But what that’s done is it’s really put a governor on supply going forward. So construction costs over the last four years are up 25 to 40%. You’re looking at a natural governor on new supply and competition coming. I think the market is seeing that by virtue of having those higher rates. And then I’d also say that there’s a couple other things at play. So rights are much more operating intensive than they had traditionally. We used to go back to pre-game, see, and we talk about, you know, the big four retail resi industrial office today. The non big four is nearly two thirds of the index. So you’re looking at things like senior housing, extremely operating intensive data centers, newfangled property type that arguably can withstand that and but also operationally intensive. And then it also say like spheres which are new since this time around and this rate hiking cycle which you could make the argument very strongly that higher rates is good for that business because of the rent to own mix between the two. So I’d say collectively there’s, there’s the index itself has changed a fair amount. And I’d also say that the, you know, them being that pure rate proxy is no longer at play because of the context of how we’re entering this rate hiking cycle and holding off supply.

00;03;00;11
Uma
Yeah, I think especially if you even think about things like earnings. Right. A senior housing exposed company is still seeing really fantastic earnings growth. And so how do you kind of play that with what’s happening across across the right market. Maybe Rob turning to you. We’ve gone through like I said earnings season. We’ve been through a couple of conferences maybe. What is one data point or one thing that you learned over the last couple of weeks that maybe has changed your perspective in terms of where we might be in the real estate cycle? Taking taking it away from equities and talking about real estate, which is which is what we do here.

00;03;30;17
Rob
Sure, sure. So Patrick and I and team was were recently at a large industry conference. And we sit down with the major players, primarily public, and they all have a story to tell, right? And whether it’s good times or bad times, you’re hearing the same story. We sat down with a large, privately owned industrial player, one of the largest out there, and they gave us some interesting data points. So internally they model out expected rent rents quarter on quarter. So for the next quarter. So for third quarter they raised their rent growth expectations for the first time in 13 quarters. So that’s a pretty notable data point and suggests a potential inflection in industrial. And I think it really goes back to what Patrick hit on, which is we went through a pretty heavy wave of supply. So it starts with starting the construction cycle, right. That takes a period of time. Then there’s completion and then the building sit on the market. If it’s not a very tight market, which it wasn’t really for industrial because they went through a post-Covid boom of demand where companies and tenants took a little bit too much space, then they took less space because they had already absorbed all that space. And that coincided directly with all the supply coming on the market. Right. So we had too much supply for an extended period of time. It seems like we’re at the back end of that, where supply vacancy is still a little bit higher than normal, but it’s starting to take down. Rents had been decreasing. They’re now starting to nudge up. But importantly, the supply picture looks much more favorable for industrial specifically heading into the future. So their rent growth expectations for next year is 5%. They said it’s the cleanest pathway they’ve seen in quite some time. And I think what’s important is not just for the industrial sector but for real estate generally. It’s we’re entering a period where supply should be muted. And typically when you enter those periods, you have a cycle of outsized growth for real estate broadly. I think the one counterpoint would be data centers, as we all know, which is kind of eating up all of the supply and then some. So maybe set that aside. That’s a separate conversation. We’re not necessarily a bearish on data centers. It’s very nuanced. There’s a lot of demand and a lot of supply. But for all of the other core real estate sectors, the supply backdrop looks very favorable.

00;05;43;02
Uma
Yeah, I think across all global markets, I think if you look at all the different property types, data centers aside, all of the other property types are seeing supply levels at pretty significant decreases compared to where maybe the peaks were over those last cycles. So I think we’re seeing maybe a synchronized supply coming down almost globally. It seems like but industrial is a great place to kind of kick off. The next thing I wanted to dig into, maybe Patrick with you. If you think about industrial as a sector, the one market that I think has just been really, really under pressure has been Southern California and in part has been this combination of supply and demand kind of combining together, creating for some tough fundamentals. It seems like maybe we are seeing an inflection point in Southern California. What are you hearing from the reads broker report, etc. as you’re thinking about the Southern California market?

00;06;36;10
Patrick
Yeah, I think you’re exactly right that it was very clear that Southern California ran the hardest during the improvement in terms of rental rates, just explosive rent growth for for quite a number of years. And when it gets down to it, it’s also fallen the furthest in the face of this supply. So it was a very tight market. It fell meaningfully over the last 3 or 4 years. And I think there’s a couple of things at play. So the characteristics of Southern California industrial, yes, it had a lot of supply that took kind of the top off the market. There was also at play Phoenix as an escape valve market for that. So we saw over the last three years the Phoenix industrial market see some of the best fundamentals ever had, particularly for 3PL large warehouse logistics space. And that is effectively full now. So we’re now seeing that escape valve being taken away amidst supply coming down in Southern California. So the recent Q2 data was very strong. We saw 40 basis point down tick in vacancy in that market. We saw leasing year over year admittedly on a very low basis, but year over year up over 40% to Q of 25 versus this to Q. And so I think there’s reasons for green shoot, but it’s really seen basically as a function of that Phoenix point that I made where big box is clearly outstripping. There’s there’s very there’s a dearth of big box availability in Land Empire now. And it’s a function of that escape valve being taken away on the Phoenix side for sure. And then it also say that I don’t want to be too Pollyanna and to positive with this, but because of my first comment with how much rates have run, we do still admittedly there’s some green shoots in leasing, but we do still have minimum of two years of negative mark to markets. For a lot of those rents that were signed during the heydays of the Southern California industrial market. So there still is some healing that needs to take place. But I would agree that for a market that was, you know, kind of the highest flying across the industrial rally coming out of Covid, as Rob pointed out, it’s had to come off the boil quite a bit and there’s still a little bit of pain left. But the leasing data in real time data does suggest that we have some healing going on right now and reason for possible green shoots.

00;08;47;24
Rob
It’s interesting you mentioned Phoenix. That market came up specifically as a case study in this in this meeting at the conference. And they said that for their portfolio, which I think is reflective of broader portfolio, is vacancy went from 14% to 2% today in Phoenix. So it’s tight and you’re seeing escape valve is closed. Exactly right.

00;09;05;08
Uma: Interesting. And I think similar to maybe Southern California industrial, one of the other areas that we were seeing just really pressured fundamentals for what seems like two plus years now as life sciences went through a similar supply glut. And it was not only just new life sciences buildings, it was everybody who had office that wanted to convert it to life sciences.

00;09;26;14 – 00;09;41;13
Unknown
And at the same time, you’ve seen some pressure on demand as well. It seems like maybe that is another part of the market where we’re seeing a bit of an inflection fundamentals. So maybe, Rob, to you in terms of what you’re seeing there, anything from the rights or the market in general as you’re thinking about the life sciences sector?

00;09;47;18
Rob
Sure. Yeah. Life science similar to industrial, but outside I would say where the supply came in hot and heavy was everybody’s favorite sector to build everybody’s favorite. And there were, you know, markets and still are markets with 30 plus percent vacancy. Brand new beautiful buildings that are just sitting empty. So it’s it’ll likely be a long road to recovery. But we are seeing green shoots of demand. We’re we’re getting feedback that the touring activity is picking up. The interest level is picking up and specifically for higher quality in some of the better submarkets. So while I wouldn’t expect a V-shaped recovery, I think that you might get a longer you or something like that. The one area that I would I would point out, though, is demand in life science is a little bit different from maybe traditional real estate demand. So industrial, for example, or maybe apartments is a good example. We have a pretty good read of supply A, but B demand demands a function of population job growth. Life science demand is is pretty unique. And we could be in a period where demands could be outsized to the positive. We just heard that basically we found the cure for cancer, right? AI and what it’s doing to drug discovery and drug development could be a game changer for the sector. And that’s something that we’re cognizant of and monitoring and watching. Because if that really does change the game, I think that we could see a quicker recovery than is typical. So those are the things that we’re looking for.

00;11;10;29
Uma: Yeah. I think what’s interesting to you is that one of the key features, I think, of the life sciences spaces compared to office buildings, which it seemed like everybody was converting office to life science is it has a significantly higher power and power capacity. Right. So we’ve also heard, I think, some comments on some of these, like tech tenants that maybe just need better power access or coming to life sciences style buildings, they’re not even life science tenants, but they just need the specs that they can get in these buildings.

00;11;39;12
Rob
Exactly. Yeah. Phase one of the recovery really was kind of nontraditional life science users. So tech or just kind of hard users of space, tough tech, right, etc.. So, so they they helped absorb some of the excess space that’s out there, which is still happening today. But now the traditional, more traditional life science demand seems like it may be reemerging. So it’ll be something to keep an eye on.
00;12;03;19
Uma
Yeah, I think we also can’t really talk about real estate these days without talking about all the political headlines that I think we have to keep track of every day. Where could you be going with this? I know you’re you’re you’re close to, especially the headlines, the data center space. I think there are almost 40 states now that have some level of restriction on development. Doesn’t matter. They’re blue states. Red states really kind of taking center stage politically. How do you think about the political backlash that’s happening across data centers at large? But then maybe in particular, how do you think that impacts the rates? Because I think the impact on developers for new data centers is very different than maybe the the incumbents in, in the center.

00;12;43;01
Patrick
That’s a great point. And one that, you know, we continue to try to stress. But you’re exactly right. I mean, there’s been 77 state level measures across 39 states to date. And many pending clearly has become a bipartisan pushback. This isn’t a red state blue state thing. I think the crux of the argument, and it’s a 100% valid argument, but is ratepayer protection. So you really need you can’t be having the data centers coming in some cases having tax incentives to do so, coming in, bringing a bunch more demand on the grid and then having rates go higher. So there is definitely that at play. And that’s extremely valid. What we need to see from here, though, is a better communication across the space. You need to have information sharing of the real there’s there’s a lot of propaganda out there that I think many of which is valid and some of it is more noise. And so there needs to be an education, if you will, on some of the real uses of things like water and noise pollution that you hear about and what those actual measurables are for that. But I think we’ll come around. So for start, we’ve had some pauses go in place. You saw New York, etc.. Texas is having a more Folsom underwriting campaign right now. But I’d also say that, you know, the removal of the tax incentives is the first clear thing we’ve seen. And the markets that are the most, you know, related to what’s going on in terms of development right now would be Ohio and Arizona, both of which have announced pauses on their tax incentives for data center development coming in. And then additionally, states like Virginia putting forth a 1.1 cent per kilowatt hour increase to large data center users in there. So there’s little things on the edges. And what does that amount to? So we’re hearing, you know, more political pushback. Things are getting more expensive to operate. Well to your point what is that cater towards that moves a massive moat around incumbents. So if you already have existing data centers, 300 plus data centers globally like the rights do, that’s extremely valuable right now because replacement cost is going higher. The difficulty of that competing supply to come in is much more difficult. And so if you have an existing platform, huge amount of moat around your business now to come and compete, that’s going to accrue to the incumbents, as I said. And so I think you’re going to expect I would expect more pricing power going forward for the two big behemoth rights in their spaces and really key markets that they operate in. Not so much. The father flung markets that we’ve been reading about where a lot of the hyperscale developments going, but in the key markets like Northern Virginia, like Dallas, etc.. So I would expect this to play into the incumbents hand, which are the reeds.

00;15;29;07
Uma
Yeah, absolutely. I think very different conversation. If you’re trying to build a hyperscalers training center in West Texas, compared to if you have really high density, kind of interconnected data centers and in these core markets. Robbie, turning to you on a different set of political headlines. But it seems like from the perspective of New York City, for example, I think everybody was really worried about the impact of the mayoral race and what it would mean for local office demand. We have seen Manhattan office just really off to the races, I think, firing on all cylinders. Do you think there’s something happening that’s very specific to New York that’s driving that? Is that an office recovery in general? Because it definitely seems at odds, I think, with what a lot of people expected, given kind of the political backdrop.

00;16;16;23
Rob
Yeah, it’s a great point. The the headlines came in hot and heavy with the Mamdani election and caught some off guard. I would say that the headlines were a little bit louder than actual policy changes, as they tend to be. Right. And, New York is maybe a microcosm of what’s going on nationally, where demand for very high quality trophy office is extremely high and supply is very low. Supply has been low for office for a long time. It’s been kind of red lines that was you know, everybody’s favorite sector to hate. And now it’s coming back. If you look across all the different real estate categories market rent growth and office is amongst the highest right now for the type of properties of the REIT’s own. And New York, I think, is maybe one of the best markets, San Francisco as well, because of the what’s going on with AI. But New York has the deepest bowl of tenants that are able and willing to pay the rents necessary to be in high quality space, right? The 200 plus dollars per square foot space. So, it’s pretty much almost an arms race now for companies to get that attractive space because the the need to attract and retain employees is very high in this environment. So, yeah, little supply and a lot of demand means good thing, good things for real estate.

00;17;41;13
Uma
So yeah, maybe just to double click into something that you said. Right. You mentioned that the Reed’s own really just the best product in the marketplace. And I think that’s really indicative of the Reed’s position, not just in the office market, but across so many different sectors where they tend to own the higher quality product. And so we we have, you know, opinions about the life sciences sector or the office sector. And I think they tend to be much more reflective of the higher quality, best located assets, because I think if you were to talk about office, but maybe talk about commodity, classy product and suburban markets with no access to transportation and public transit, you would be having a very different opinion of the office market. So it’s interesting to to highlight, I think, just the fact that the rights tend to own a lot of the best product across these different sectors. And so. We talk about rights, owning the higher quality product. I think the other thing that the rights tend to have on vantage of really relates to the capital markets, whether it’s accessing capital from the equity perspective, from the debt perspective, or even potentially taking advantage of very large dislocations and valuations that they can trade out in the equity markets, versus maybe what private assets would trade at in that market. At the same time, we’ve seen M&A, we’ve seen a lot of privatizations, we’ve seen a lot of equity issuances, a lot of debt issuances so far this year. So maybe Patrick talked to us about how you view the rights of capital markets advantage in the current environment.

00;19;07;18
Patrick
Yeah, absolutely. It’s a big advantage to and it becomes more pronounced as rates continue to go higher. So to put things in perspective, on an implied leverage basis, rights are at 26% levered right now, and they’re running at high fives times net debt to EBITDA. If you would put that in a private real estate wrapper and that would be laughably low leverage, you know, where you’re normally seeing 60, 65, sometimes even 70% loan to value in that space and significantly higher net debt to EBITDA. They’re also 90% fixed. So we have very little rate exposure going forward. Only 10% floated. And the average debt term is almost six full years, just just south of six years of debt terms. So the the balance sheet work, especially relative to GFC where we were in the mid 40s levered going into GFC is it’s incredibly different. It’s such a better position. So as rates move higher, you see not only higher leverage in the private space relative to the rates, but greater amount of variable rate debt. That’s really pinching on the the private players right now. So it’s opening up acquisition opportunities. You’re seeing a little bit more distress in some property types. That’s allowing for more creative acquisitions for the right side. And then I’d also say just in general, the capital raising this year has been really, really strong for the reeds, not only in capital raising for M&A deals, but just general. We’ve had 20 billion of capital raised year to date. That’s up year over year. We’ve seen issues of ATM. So at the money equity issuance really coming into play. That’s been up year over year in terms of utilization, which allows them to just kind of spoon feed some equity into the market. And then also I’d say convertible debt has become the, you know, the the invoke usage. So you’re basically able to get these very, very low coupons and, you know, admittedly has some equity dilution, possibly in the future, but materially up from where your your share price is today seems to be pretty attractive. I mean some of these have one handles on in terms of the actual coupon rate so wildly outstripping. And that’s being done and made possible by having these better balance sheets. This wouldn’t be the case. Somebody doing convertible this 1314 times net debt to EBITDA would come with a very different coupon. Obviously in terms of the credit risk that would be there. And I guess on the M&A side, I’d say we’re having a record year of $67 billion in M&A activity. That compares to more like 14 or 15 billion all of 2025. So we’re already wildly outstripping that. And we really seen it in two main areas. I would call out to big spaces. So the US multifamily space had a large merger in that space. And then also within the European industrials based on a global basis. We saw a large U.K. listed name also get merged with or taken out, so to speak, in that deal as well. So two big deals. And when I look at what that’s meant or what the driving factors are, I would say first and foremost it would be scale. So just improving your cost structure cannot be overemphasized. In a rising rate environment, you try to find savings operationally anywhere you can. And so that makes a lot of sense for getting that scale. And then I’d also say that the balance sheets themselves being strong is very helpful because in this environment, you want to consolidate all of your liabilities and all of your capital into its lowest cost area. So you have these big, big entities that, you know, we all know who we’re talking about in the industrial space that have a very, very low cost of capital. It’s best placed in the hands and on that balance sheet to be capitalized, because it’s more important ever right now with how much rates have run to be able to put that in the lowest cost environment, so to speak. And so I would put those two things scale and finding the best, lowest cost of capital balance sheet to place those assets in as being the drivers of them. And a senior aide.

00;22;57;14
Uma
Yeah, absolutely. A lot of different moving pieces to your point, Rob, maybe to to close out as we think about what the market has so far told us this year, as you look into the end of this year, looking into 2027, what do you think investors are missing the most about the right sectors?

00;23;14;26
Rob
Yeah, I think it’s a thread that we’ve touched on throughout the conversation. But the supply picture and what it means for real estate going forward, I think is a very important one. You know, you talked about higher rates here and it can be a little bit counterintuitive. Higher rates inherently are not great for for real estate owners. Right. But the rights to Patrick’s Point have much lower loan to value ratios than the private market, right. So when rates go up and you’re competing on acquiring a building, if the the other bidder is using 70% LTV bank debt and you’re more funded with equity and you can access the unsecured bond bond market, you can be a little bit more competitive. So that’s an advantage. And then the second is what it does to development. And it starts to shut off development. And you combine that with the data center build out that’s going on and what that’s doing to cost of labor, cost of steel. Some of the inputs into construction, the not only the near term completion outlook, but also the outlook for new starts in general looks a lot more favorable. So I think that’s probably the the key here where the market might be a little bit overly focused on what is nowI growth this quarter and next quarter. And they’re not thinking out to next year and two years and three years from now. I think that’s that’s a big piece of maybe where the market might be overlooking things. So it’s and lastly, I think, you know, bonds trade as it reads, trade as bond like products often. And if you forget about the growth component of reads, it can be pretty detrimental to your underwriting. And I think that rights we just came back from the conference, as I said, in 75% of rights said that they would expect higher NOI growth next year relative to this year. So fundamentals are accelerating. Yes, interest rates are moving higher, but the backdrop is actually quite favorable. So those are probably the the overarching themes that might be overlooked today for the market broadly.

00;25;08;08
Uma
Yeah. It’s interesting right. Because you would essentially be able to look at the growth which is accelerating to your point. And then Patrick, to your point that you made in terms of the balance sheet, exposure to higher rates, the impact is much more muted. And so if you look through in terms of what earnings growth looks like for the reads, definitely paints a different picture, I think, than what just a pure and just rate proxy might, might, might take into account. The other thing that I think is interesting too, from the standpoint of looking at interest rates, is that yes, you can think about the impact of interest rates on real estate, but it’s a very different environment when you’re in a higher inflation type of environment, right, where real estate, to your point that we’ve made multiple times, right. Replacement costs are increasing. Real estate is capturing some of that inflation. And when you’re thinking about sectors like lodging or rental housing, places where you can kind of mark to market those rents much more quickly, you can capture the inflation on the revenue side, a lot of good things, I think maybe people overlook and they just think about the impact of interest rates. So it’s been a great residual value up in that scenario. Two. Right. So you can come growing residual value up. So very much so. So I think this has been a really great conversation to highlight a lot of what we’ve seen on the ground from the market over the last few weeks. Thank you, both of you for joining us today. It’s great to be here. Absolutely. And thank you to all of you for tuning in. We will be back in two weeks with the next episode of Front and Center.

00;26;39;21
Outro
Thanks for listening to Front and Center. You can subscribe on your favorite streaming platform, and please be sure to leave us a review to stay up to date. You can visit our website at center square.com to access our thought leadership. Sign up for our mailing list or contact our team. We look forward to hearing from you! The content of this podcast is informational only and represents the viewpoint of the presenters at the time of recording. It should not be regarded as a solicitation nor investment advice. All information presented is subject to change at any time based on new data analysis on market conditions. Past performance is no guarantee of future results.