The recovery in commercial real estate accelerated this spring, according to the news from second quarter REIT earnings reports. Earnings of all equity REITs, as measured by funds from operations (FFO), rose 19.8% in 2021:Q2 compared to the prior quarter. Significantly, FFO of the REIT sector as a whole rose slightly above the peak level prior to the pandemic, and has fully recovered from the declines in earnings experienced during the shutdowns and social distancing of last year (aggregate REIT earnings figures are reported in the Nareit T-Tracker, a comprehensive measure of REIT earnings and operating performance. Full disclosure: I am senior economist at Nareit and help produce the quarterly T-Tracker).
This earnings recovery, while brisk, has been uneven across property sectors, mainly due to their different experiences during the first year of the pandemic. Some sectors in commercial property markets felt the full impact of the shutdowns and social distancing measures last year. These COVID-sensitive sectors include lodging and resorts, retail (including regional malls), and health care (which includes senior housing and skilled nursing facilities). FFO of these sectors declined 40.8% from 2019:Q4 through 2020:Q4 (dark blue bars in first chart).
Some sectors of commercial real estate benefitted from the shift during the pandemic from physical interactions to the digital realm. Increased use of online teleconferences, email and data communications boosted traffic for cell towers operated by the REIT infrastructure sector, as well as data centers that host internet web sites and store and transmit online communications. The goods that people bought online often were shipped through a logistics facility owned by the REIT industrial sector. These digital economy REIT sectors had a 14.5% increase in FFO from 2019:Q4 through 2020:Q4 (light blue bars).
Other sectors, including office REITs, residential REITs, self storage REITs and others, had a moderate decline in earnings last year, with FFO of these sectors decreasing 6.1% from 2019:Q4 to 2020:Q4 (grey bars).
Commercial real estate markets are far from fully recovered, of course, despite the rebound in REIT earnings. Occupancy rates remain depressed, especially among hotel, retail, office, and health care REITs. Occupancy is rising as the economy reopens, but at current speeds will not be fully recovered until late 2022. Furthermore, a rising rate of new cases of COVID-19 from the Delta variant may cause setbacks that delay the recovery.
Trends in real estate earnings this year, however, provide encouraging signs that the sectors that bore the brunt of the pandemic-induced shutdowns are recovering faster than had been anticipated. Management teams of REITs across several sectors have said they are signing new leases at a record pace. Some REITs have reported they are collecting past-due rents they had previously written off as unlikely to be collected, suggesting that commercial tenants are recovering as well.
Earnings growth is benefitting from rapid increases among the sectors that had been most exposed to COVID-19 last year. Retail REITs and lodging/resort REITs accounted for nearly half of the increase in FFO during the first half of 2021 (chart 2). As new retail tenants continue to sign leases and as travel volumes begin to recover, earnings are likely to continue to rise in these sectors.
Investors have noticed the robust recovery in commercial real estate, and REITs have been among the leading sectors in stock market returns this year. As of August 10, 2021, REITs have had a year-to-date total stock market return of 24.7%, compared to the 19.1% year-to-date return of the S&P 500. With REIT earnings having risen back to pre-pandemic levels and on track to continue rising, the operating fundamentals of REITs are supporting this stock market performance.