As managing director and head of real estate and lodging research at Citi, Michael Bilerman and his team cover some 90 real estate and lodging equity securities and have consistently been ranked as a top team in external client polls, including Institutional Investor and Greenwich Associates.
Michael Bilerman, the recipient of Nareit’s 2020 Industry Achievement Award, has a career in real estate that spans more than two decades. Known for his keen insights into the industry, Bilerman has also provided valuable support to various real estate industry organizations, including The Real Estate Roundtable, the Pension Real Estate Association, and the NYU Schack Real Estate Advisory Board. Bilerman has also served as a cabinet member on Nareit’s Real Estate Investment Advisory Council. He recently spoke with REIT magazine on how the REIT sector navigated challenges in 2020 and what lies ahead in 2021.
You started your career in Goldman Sachs’ real estate investment banking department in 1998 and have remained in real estate ever since. Was that happenstance, or was there anything in particular that put you on a path in real estate specifically?
I wish I had this great story of following in the footsteps of Mort Zuckerman, a fellow Montrealer who attended my alma matter McGill University, but it was complete happenstance. When I learned about the industry and its opportunity, I was so excited given how vast the real estate industry is, cutting across so many different property sectors and geographies.
Both you, on an individual basis, and your REIT team at Citi consistently rank in the top of your field for REIT research and analysis. What’s the secret to that success?
Teamwork. I know it is a bit corny, but I believe our success has been driven by our collective efforts. We work well as a team with strong communication and partnership between us, and we leverage each other’s strengths.
The pandemic has certainly shaken REIT values. Has that created buying opportunities for investors? If so, which sectors look most attractive?
As landlords to the broader economy, REIT stocks should be able to recover lost ground in 2021 as the world moves past the current COVID-19 pandemic and begins a new growth cycle.
While it is likely the current impact of the pandemic, with increasing restrictions and lockdowns, could negatively impact near-term results and increase trading volatility, we believe investors are looking through current operating weakness and calibrating to future results and the longer-term property sector impacts from the pandemic.
Our positive bias on the REIT sector is supported by: the economic recovery; attractive valuation to equities and fixed income alternatives; improving fundamentals versus a weak 2020; significant private capital on the sidelines; a continued low interest rate environment; wide access to well-priced capital across the capital stack; and above-average dividend yields.
The key risks in our call relate to macro variables. The most significant of these is COVID-19, where we could see a slower-than-expected vaccine rollout and a lack of effectiveness controlling the virus, which could lead to a deeper economic trough, and hence, an impact on landlord cash flows and asset values. In addition, political uncertainty, regulatory impacts, and deficit concerns remain key risks.
How do dividends factor into your thinking about 2021?
Another catalyst for REIT shares is the potential for dividend upside, alongside the earnings recovery. While REIT dividends are below historical averages as a number of companies within the more impacted sectors reduced or suspended their dividends, we see the prospect of reinstated dividends in 2021, which could help spur additional income growth and returns.
Payout ratios remain below historical averages, providing the opportunity for dividends to grow alongside cash flow. On the earnings growth front, we estimate AFFO is expected to decrease about 1% in 2020 (excluding the lodging REITs), while earnings are expected to recover in 2021 with AFFO growth of around 5.5%, and then grow of approximately 8% in 2022.
This growth is being driven by a recovery in operating fundamentals, external growth activities, re-financing of capital, and the retention of free cash flow. Investment activity is expected to continue to pick up next year, and combined with prolonged reduced interest rates, help support our positive return outlook.
Clearly, some sectors have been more severely impacted than others during the pandemic. What’s your outlook for the hospitality and retail real estate REITs specifically?
Despite the significant impact from the pandemic, we believe the lodging space stands at the beginning of a multi-year recovery as operating results improve with better demand trends, limited supply growth, and leaner operating models. While timing remains fluid, largely driven by timing and acceptance of vaccines, we believe the outlook continues to improve as we move through 2021. That said, we anticipate a bumpy road on the way to recovery.
On the retail side, we favor open-air/essential retail and the capital positioning of shopping centers in this environment over enclosed regional malls—an area where we expect operating and capital positions to remain strained.
On the mall side, we continue to believe the mall sector will be disproportionately negatively impacted by the pandemic given near-term concerns around rent payment, tenant fallout, liquidity risk, and rent roll down. While we feel better having some clarity on a return-to-normal timeline for the economy, we think it will take time for the mall sector to stabilize.
We expect to see more permanent NOI impairment as the pandemic has accelerated pre-existing structural changes to brick and mortar retail and discretionary spending habits. With capex needs rising and tenant fallout likely to accelerate over the next six months, we remain cautious on the sector.
On the other hand, open-air strip centers have been less impacted by mandated closures and have seen a quicker return in traffic levels versus enclosed malls, driven by more necessity-based tenant exposure and more curbside pickup optionality. Grocery store visits remained strong throughout the pandemic, helping to maintain regular traffic to centers. Rent collections have reached a more stable level, which has improved cash flow positions and allowed many REITs to start reinstating dividends.
There seems to be a bit of a wait-and-see approach on how other sectors such as office, multifamily, and student housing may be affected. What’s your view on the challenges ahead in these sectors?
Trends in the office space have been dominated by FOMO, or fear of missing out, as investors (both direct and equity) watched share prices drop to levels that implied a big discount to private values earlier in the pandemic. Recent rebounds were volatile, and work from home impacts come back to human psychology and the optics and interactions of being in the office.
Valuations remain depressed but fundamentals aren’t necessarily much better, driving sentiment that remains largely negative. We expect that the office sector will underperform and are underweight in our model portfolio as near-term upside would require a significant positive shift in fundamentals or industry trends, something that we simply don’t see near term.
We expect the broader residential sector to outperform and favor manufactured housing and single family rentals over multifamily and student housing. Within apartments, we expect operating results to continue to feel the impact of COVID-19, mainly through pressure on effective rent change as REITs use concessions on stabilized assets to maintain occupancy in many coastal/urban markets. We expect the Sunbelt markets to outperform operationally versus coastal markets. The apartment REITs have shown resiliency in rent payments, trending above the national average in collections.
Looking ahead to 2021, what do you think of the opportunities ahead for some REITs to shift to offense and be aggressive on property acquisitions or even potential M&A deals?
While transaction volumes have decreased significantly driven by the pandemic, volumes are likely to rise over the next 12-24 months given a continued record level of “dry powder” raised for real estate investment, as well as the capital markets for REITs being generally open with a number of financing options at the company and asset level.
In addition, as vaccines continue to be deployed and have the desired effect, CEOs will have the confidence to begin to plan more meaningfully for the future and look at external growth possibilities. Shareholder activism also remains front and center in the real estate industry, which could push sellers to look at possibilities.
In terms of combinations, certain acquirers will benefit more significantly from synergies which can be created via public to public combinations, and also take advantage of a superior cost and access to capital.
While social issues still can impede deals from occurring, and usually are the biggest inhibitor to REIT M&A from a portfolio perspective, there are also significantly less “unwanted” assets in REIT portfolios today as many companies have honed their strategies and asset focus over the past 10 years. This means that acquirers are not inheriting other people’s problems.
Lastly, it’s just in the numbers. With about 180 publicly listed REITs and varying valuations, the likelihood for deals is there.