Last year was a challenging one for real estate investment trusts (REITs). The COVID-19 pandemic impacted many tenants' ability to pay rent, which affected REIT cash flows. As a result, the sector produced a -5.2% total return last year.
However, the worst seems to be over for the REIT sector, as operating metrics across the industry are improving. Here's a closer look at some of the numbers that matter for REIT investors.
A recovery is underway
Overall, the REIT industry generated nearly $52.4 billion in funds from operations (FFO) in 2020, according to NAREIT. That's an 18.5% decline from 2019's total. However, FFO has steadily improved after bottoming out during the second quarter. It rose 10.3% sequentially in the third quarter and followed up with another 11.3% improvement in the fourth. That put FFO 16% below its pre-pandemic level.
The main driver of the decline was lodging and resort REITs. The group's FFO was -$500 million during the fourth quarter, well below the $1.1 billion in FFO it produced in the pre-pandemic fourth quarter of 2019. Low occupancy rates have hurt hotels, causing most to lose money last year. On a more positive note, hospitality REITs have seen a noticeable improvement in recent quarters, after FFO bottomed out at -$1.2 billion during the second quarter when government-mandated shutdowns and travel restrictions battered the sector.
Retail REITs were another weak spot last year. FFO plunged from more than $3.3 billion at the end of 2019 to a low of around $2.3 billion in the second quarter of 2020 before recovering to nearly $2.6 billion by year's end. Government-mandated shutdowns also weighed on the retail sector, making it harder for nonessential physical retailers to generate enough sales to pay their rent.
FFO has also been under pressure for office REITs, apartment-focused residential REITs, and healthcare REITs since the pandemic started due to an increase in remote work and the devastation it caused to the senior housing sector. On a positive note, FFO has recovered from its lows across all three sectors.
A headwind for some was a tailwind for others
The pandemic hasn't negatively impacted the entire REIT sector. Industrial REITs and single-family rental residential REITs have benefitted from the pandemic. It accelerated the adoption of e-commerce and led remote-working renters to move into bigger places in the suburbs.
For example, leading industrial REIT Prologis (NYSE: PLD) grew its core FFO per share by nearly 15% last year. Driving that growth was that the "the pandemic has pushed global supply chains to their limits,” according to comments by CEO Hamid Moghadam. That was the result of the increased e-commerce adoption and the rebuilding of inventories to meet consumer demand. The company expects those two tailwinds to drive additional demand for industrial real estate over the next several years.
REIT investors are starting to notice a difference
While REITs produced a negative total return last year, the sector has bounced well off its lows. That recovery has continued in 2021 as REITs have generated a more than 4% total return this year. Driving that recovery has been last year's laggards, as retail REITs are up more than 15% this year after producing a -25% total return last year, while lodging REITs are up more than 17% after posting a nearly 24% negative total return in 2020.
REIT dividends are also making a comeback. According to NAREIT, REITs paid out $12.1 billion in dividends during the fourth quarter. That's 3% higher than the third quarter. Unfortunately, overall dividends from the sector are down 28.8% year over year.
Driving the recovery in REIT dividends is the retail sector. Most retail REITs suspended their payouts during the second quarter to preserve cash as rental payments dried up. However, many have reinstated their dividends in recent months as rental collection rates have improved.
For example, leading shopping center owner Kimco Realty (NYSE: KIM) suspended its dividend during the second quarter due to the economic uncertainty caused by the pandemic. However, as its rental collection rate improved throughout the year, it gave Kimco the confidence to bring back its dividend. The REIT started by paying $0.10 per share in the third quarter of 2020, down from its prior rate of $0.28 per share. It has since increased its payout to $0.16 per share in the fourth quarter and $0.17 per share for 2021's first quarter.
Most other REITs that either suspended or reduced their dividends in 2020 are taking a similarly cautious approach to bringing them back, given the ongoing uncertainty. Many payouts likely won't return to their former peaks for quite some time, if ever, as the sector will probably trend toward more conservative dividend payout policies in the future to retain more cash for additional financial flexibility.
Still in the early stages of the REIT recovery
REITs are seeing improved cash flows as governments lift restrictions on travel and nonessential business. That has helped boost their stock prices and ability to pay dividends.
However, the sector hasn't bounced all the way back. While that will take time, a return to normalcy seems to be around the corner, given the rapid rollout of vaccines, which should enable people to freely travel and return to their offices. That suggests REIT stock prices and dividends could continue heading higher in the coming quarters, making the sector look like an attractive investment opportunity as its recovery continues.