Public real estate investment trusts' share price performance has been lackluster in recent quarters, but the perceived cheap valuations in the space may not be unjustified, a prominent industry analyst said.
At REITWeek last week in New York, Citi equity research analyst Michael Bilerman put forward a thesis that the "deep" REIT discounts that industry players have lamented for months might not be so deep after all.
"I wouldn't call them substantially undervalued," Bilerman said of REITs at Nareit's annual conference in New York. "And I think the REIT sector, because it's torn between [net asset value] and multiples, that's sometimes why you get different answers."
Bilerman noted that generalist investors tend to focus on cash-flow multiples rather than NAV estimates in their assessments of value, and that by that measure, public REITs are trading about in-line with the broader market. "The FFO growth has decelerated to the low-mid single digits, while the broader market, stimulated by ... tax reform, has been able to put up much higher growth," he said.

Retail REIT shares have exhibited particular weakness of late, as secular changes in consumer behavior have upended decades-old business models, forcing many retailers to downsize or fold, leaving swaths of space vacant. As of June 7, regional mall REITs traded at a median discount to NAV of 29.4%, and shopping center REITs traded at a median discount of 18.4%, according to S&P Global Market Intelligence data.
Office REIT shares also have shown weakness, with a median discount to NAV of 14.9% as of the same date.
Jeffrey Horowitz, global head of real estate, gaming and lodging investment banking at Bank of America Merrill Lynch, said the NAV metric itself is problematic, insofar as it represents "only a guide" to the potential liquidation value of a company.
"In many cases, when we get under the hood of the company, we find all kinds of breakage costs. It could be a ground lease, it could be ... a [joint venture]. Whatever it might be, it actually changes what their real NAV is," Horowitz said.

Others took a less contrarian stance on the issue. Sherry Rexroad, managing director and chief investment officer for the global real estate securities group at BlackRock Inc., attributed the "dislocation" in REIT valuations to the widely shared perception that rising interest rates negatively impact REIT valuations, at least in the short term.
"In the longer term, all of us, I think, are believers that real estate is pro-cyclical," she said.
Rexroad noted that lodging company valuations have already improved and pulled away from the rest of the real estate pack, boosted by favorable conditions in the broader economy, the segment's shorter lease terms — nightly room rates — and a spurt of M&A activity.
In an interview, Brad Case, Nareit's senior vice president for research and industry information, took issue with the dominant narrative that interest rates are the primary reason for the ongoing REIT discounts, today and during previous episodes of REIT underperformance.
"I think this idea that REITs have done badly because of increases in interest rates, real or expected, is simply wrong. ... I can't deny the patterns that we've seen at certain times. I'm denying the explanation," he said.
Case pointed to several junctures where REITs performed well amid the prospect of rising rates, including late 2014 and early 2015, when REIT indexes moved to record highs even after then-chairman of the Federal Reserve Ben Bernanke signaled that the Fed would begin to taper its quantitative easing program and that interest rates would soon increase.
"Our industry thrives on stories," he said. "Very few people do one of either two things: One, ask if the story makes sense, and two, ask whether it's supported by actual data."

