Despite significant leasing activity in 2023, Real Estate Investment Trusts (REITs) experienced modest growth in funds from operations (FFO) per share. Dane Bowler, writing for Seeking Alpha, points out that while discussions often focus on interest rates and cost of capital, other less-discussed factors played a crucial role.
Robust Leasing Activity with Tepid FFO/Share Growth
2023 saw impressive leasing numbers across several REIT sectors. Retail lease rental rates increased by 20%-40%, industrial rents surged by 40%-50%, towers experienced approximately 6% organic billings growth, and manufactured housing showed a same-store NOI growth of 6%-15%. Despite this, FFO per share grew only fractionally, suggesting underlying expenses may have played a significant role.
The Surge in Uncontrollable Expenses
REITs typically manage various operating expenses through efficiency improvements. However, property taxes and insurance costs—largely uncontrollable—saw significant increases in 2023.
-Property Taxes: Inflation led to higher assessed property values, resulting in increased property tax obligations. Data shows property taxes jumped from $170 billion at the start of 2023 to nearly $200 billion by year’s end.
-Insurance Premiums: Insurance costs, which factor in building replacement values, also saw substantial hikes. For commercial real estate, insurance expenses grew from 1% of revenues in 2018 to 2.3% by the end of 2023, reflecting a significant increase over five years.
Impact on Margins and FFO
The rise in insurance premiums effectively reduced REIT margins. An increase of nearly a full percentage point in insurance costs cut into FFO margins by about 100 basis points. Given that FFO margins were around 40% in 2023, this equated to a roughly 2.5% hit to FFO/share.
Property taxes, which vary by state and depend on the revenue generated by property types, also played a significant role. Although it is challenging to quantify the exact impact, it is clear that higher property taxes contributed to the reduced margins.
Looking Ahead: A More Optimistic Future
The rental rate increases from 2023 will gradually reflect in revenues over several years, while the immediate hit from taxes and insurance has already been accounted for. Early indications for 2024 suggest a moderation in both property tax and insurance expenses. For instance, Camden Property Trust (CPT) revised their 2024 property operating expense growth downward, citing favorable real estate tax valuations and lower core insurance claims.
While REIT margins suffered in 2023 due to soaring insurance premiums and property taxes, the long-term prospects look brighter. Investors should remain vigilant about these expense categories as they can significantly impact margins, even when overall operating expenses appear stable. This analysis underscores the importance of scrutinizing all elements of REIT expenses to understand their true financial health.
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