Last year was one of the best years in decades for real estate investment trusts (REITs). The FTSE Nareit Composite delivered a total return of slightly more than 40% for 2021, its best performance since 1976. That was significantly above the broader market, as the S&P 500 delivered a nearly 29% total return for the year.
While all property types performed well, a few sectors helped propel the industry's big gains last year. Here's a look back at what drove REIT performance in 2021 and whether that will continue this year.
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The fab four of 2021
The biggest standout in the REIT sector last year was self-storage REITs. The average one delivered a total return of nearly 80%, led by Extra Space Storage (EXR 1.02%), at 101%. The big driver was scorching-hot demand for self-storage space as people decluttered or relocated during the pandemic.
Next up were industrial REITs, which delivered an average total return of more than 62%, led by Plymouth Industrial REIT's (PLYM -1.60%) nearly 122% total return. The big driver was the insatiable demand for logistics space, driven by the accelerated adoption of e-commerce and a shift in inventory management practices caused by the pandemic.
Residential REITs delivered more than 58% in total returns last year, led by the almost 160% total return by Preferred Apartment Communities (APTS). The driving factor was a tight housing market, which drove up occupancy levels and rental rates for apartments and single-family rental homes.
The final noteworthy big gainer in the REIT sector was retail REITs. Last year, the average one delivered a nearly 52% total return, led by InvenTrust Properties (IARE -0.23%) at 152%. The primary driver was the recovery in the retail sector as government restrictions on nonessential retailers lifted. That enabled consumers to shop in physical stores again and retailers to catch up on their rental payments.
Can REITs maintain their momentum in 2022?
Last year was an outlier for the REIT sector, driven by the pandemic. REITs staged an epic rebound following the pandemic-induced downturn of 2020, a year that saw the average REIT deliver a total return approaching -6%. On top of that, the pandemic proved to be a tailwind for several sectors, helping drive outsized gains in rental rates and property values. With some of these catalysts fading in 2022, investors shouldn't expect REITs to deliver a repeat performance.
However, the sector will benefit from some continued pandemic-related tailwinds in 2022. For example, leading industrial REIT Prologis (PLD -1.57%) sees unstoppable growth ahead. Pandemic-driven catalysts like accelerating e-commerce adoption, supply chain disruptions, and inventory restocking have the U.S. in need of an estimated 800 million square feet of new warehouse space in the coming years. That has Prologis projecting rent growth of around 10% this year. On top of that, it sees additional earnings growth supported by new development projects. Because of these catalysts, industrial REITs could continue delivering strong performance in 2022 and beyond.
Likewise, rental residential real estate will continue to benefit from pandemic-driving tailwinds. Apartment rents are growing at double-digit rates in major coastal gateway cities as workers return to their urban offices, driving demand for apartments in those cities. Similarly, apartment demand in fast-growing Sun Belt cities remains robust as more people move for jobs, warmer weather, and fewer restrictions. That demand is driving double-digit rent growth across the region. As a result, apartment REITs expect to deliver double-digit income growth this year, which should help drive their stock prices higher.
Meanwhile, a few REIT sectors haven't fully recovered from the pandemic's impact. For example, office REITs delivered a 22% total return last year, still leaving many below their pre-pandemic level after the sector's -18% total return in 2020. This means office REITs could have more upside ahead as companies return to the office this year. While the sector is facing some headwinds from increased remote work, most office REITs are seeing strong demand for office space as companies start bringing employees back to the office.
However, while the REIT sector has more upside potential, it's facing a major potential headwind in 2022 from rising interest rates. That's because higher rates increase REIT borrowing costs. In addition, it makes lower-risk alternative investments more attractive to income-seeking investors, which often weighs on REIT share prices to push up their dividend yields. If the Federal Reserve raises rates quickly to tame inflation, it could weigh heavily on REITs.
2022 could still be a strong year for the REIT sector
REITs are unlikely to deliver another 40%-plus total return in 2022 because some of their pandemic-driven catalysts will fade. On top of that, they're facing a new potential headwind from higher interest rates.
That said, REITs could still produce strong total returns this year. Some are still benefiting from pandemic-related tailwinds driving demand for certain properties. Meanwhile, some other properties should see pandemic-related headwinds start fading in 2022, lifting the weight on their stock prices.
Given these market conditions, investors should focus on REIT sectors with clear catalysts, which positions them to potentially produce the strongest returns in 2022.
