The steep discounts at which public real estate investment trust shares currently trade point to the probability of flat or moderately declining commercial property values on the whole over the next several quarters, industry players said at a March 21 conference in New York.
"We do think that the REITs look cheap versus private real estate," Jon Cheigh, global portfolio manager for Cohen & Steers, said on a panel of dedicated REIT investors. "But we think that some of this ... perceived discount to [net asset value] is probably just telling us that we're going to see little real price growth, and potentially even some nominal declines in commercial real estate values, over the next few years."
The purported theme of the NYU Schack Institute of Real Estate's 2018 REIT Symposium was the disruption wrought by new technologies, but the favorite topic of conversation was the disconnect between public and private commercial property values, which has intensified in recent months. While REIT stocks have languished, the private real estate market still feels "pretty robust," with $465 billion of transaction volume in 2017, according to Theodore Bigman, managing director and head of global listed real assets investing at Morgan Stanley Investment Management.
Bigman noted that REITs have traded, on average during the modern REIT era — dating back to the early 1990s — at a 5% to 10% premium to NAV. So, late in the cycle, one might expect many to be trading below that average, but the disconnect is "too big," he said.
"The issue is, we're way below that range. We haven't had average discounts at this level since we were well hated during the tech bubble," Bigman said, referring to the late 1990s and early 2000s period. "That was a long time ago. ... We're living in a weird world where private real estate is sought after, and public real estate securities are shunned."
The disconnect between public and private valuations sparked another line of inquiry: Why hasn't the market produced more privatizations, or more M&A of any kind?
Sherry Rexroad, managing director and senior product strategist at BlackRock, posited that the reason the REIT space has not witnessed more M&A of late is because "management has no incentive."
"It's job preservation," she said. "The way that most of our contracts are set up, [there] is not sufficient incentive to sell a company."
Rexroad also argued that the difference between the top and bottom valuations in any given real estate subsector is not significant enough to offset the sizable transaction costs of a large-scale deal for either a public or private buyer.
"The impediments to M&A are certainly there. ... The discount to NAV is going to have to be at least as wide as it is now," she said.
The conversation around pricing spilled into the lunch period, when real estate mogul Sam Zell offered a characteristically contrarian take in an address. Prolonged low interest rates have created unrealistic expectations and a skewed framework with which to assess valuations, he said. The Federal Reserve's anticipated interest-rate hikes this year will likely only raise capitalization rates on commercial property.
"I don't think the [valuation] gap is quite as large as a lot of people have written it up to be," he said.