Simon Property Group has been unloved for too long, says Morgan Stanley, and could be worth a flier. Here, a drone photo of a Simon-owned mall in Hurst, Texas.
Tom Pennington/Getty Images
The widely expected collapse in the commercial real-estate market may not come to pass, analysts at Morgan Stanley argue. If they’re right, that should be good news for investors who want to look for yield in real estate investment trusts.
The bank updated its forecasts for the market in a recent note: Analysts now expect commercial property prices to rise 5% this year, compared with their October forecasts for prices to decline by 10% to 15%.
They give a few different reasons for their new call.
First, lenders have been providing real estate borrowers with forbearance on loans and extending payment deadlines, so only 1% of last year’s commercial real-estate transactions were for properties in distress, the bank said, well below the 20% figure seen during the financial crisis in 2008 and 2009.
The analysts don’t think distressed sales will pick up much this year, either. While there is still a significant amount of stress in the market, the analysts said that lenders will likely resolve issues with borrowers over a period of years, instead of selling distressed properties and weighing down prices in the broader market.
Second, the worst of individual properties’ income declines may be over, the bank says. At comparable properties, fourth-quarter net operating income declined roughly 5%, a deceleration from the third quarter’s roughly 8% drop. While the broader sector’s income fell more quickly in the fourth quarter, with malls’ and apartments’ comparable-property income declining, the analysts wrote that the results were still “generally… better than feared.”
And finally, there is a lot of cash looking for yield that may end up in the sector. The analysts estimated that about $1 trillion in buying power was available in commercial real estate. A decent share of that is in bond funds that aren’t explicitly targeted at real estate, but Morgan Stanley wrote that real estate could provide an alternative to traditional bonds for those funds, as Treasury and other bond yields remain low.
There are plenty of reasons for caution, however, because the bank’s brighter forecast for the broader market may not play out. If there is a delayed wave of defaults driven by expiring forbearance agreements, the analysts estimate that property prices could decline 10% to 15%. The share of the market that is in distress or “shadow distress”—or properties in forbearance, delinquency or slow finding occupants—totals around $146 billion, they found.
Another big risk to Morgan Stanley’s bullish view is the $2.3 trillion wave of commercial mortgages that are coming due in the next five years. “This is the largest five-year maturity wave we’ve ever seen,” wrote the bank.
But more than half of those loans are held by banks, and it isn’t clear whether those lenders will want or need to turn up the pressure on real estate borrowers just yet. Large banks’ balance sheets have held up well during the crisis, and midsize banks with high exposures to commercial real estate should soon be able to sharply reduce their reserves for pandemic-related credit losses, Morgan Stanley said. In other words, lenders may have bandwidth—and motivation—to extend landlords’ debt forbearance if needed.
Plus, property prices may already be hinting at a turnaround. Prices rose 7% in February from the year before, the bank wrote.
All of this means that some commercial REITs could be attractive for investors who want yield and the potential for price appreciation, as other stocks trade at high valuations relative to history. Some sectors where leases turn over quickly, such as apartment REITs, could be attractive as inflation protection as well, strategists say. Morgan Stanley estimates additional returns of 7% to 8% from here, as the sector’s returns have already exceeded their prior forecasts for this year.
Within the sector, the bank’s analysts say four commercial REITs should be “core holdings:” cell-tower REIT Crown Castle International (ticker: CCI), single-family home rental REIT Invitation Homes (INVH), distribution-center REIT Prologis (PLD), and data-center REIT QTS Realty Trust (QTS).
The growth expectations for those four are more fully reflected in the price, however, so the bank recommended that investors focus on six others that have been the targets of too much market pessimism:
Doomsday Averted?
Morgan Stanley says that commercial real estate markets could be stronger than feared this year. These six REITs in unloved sectors could benefit.
Price changes as of 2:00 p.m. Monday, earnings dates with asterisks projected
Factset, Morgan Stanley
Morgan Stanley’s analysts expect retail REIT Simon Property Group (SPG), office REIT Paramount Group (PGRE), and senior-housing REIT Welltower (WELL), to outperform in sectors that are still relatively unpopular among investors. Billboard owner Lamar Advertising (LAMR) and apartment lessor UDR (UDR), are plays on expectations for a sharp rebound in economic growth this year. The bank also wrote that Physicians Realty Trust (DOC) could grow cash flow through acquisitions quicker than investors expect.
If commercial real estate does experience a delayed wave of defaults, these six may struggle. But if economic growth is about to boom, as many investors are betting, they may be a solid bet.
Write to Alexandra Scaggs at [email protected]
