REIT stocks get a lot of attention. Their debt, however, is a quieter sibling, despite $44 billion of offerings in 2023. REIT bonds make up 50% or more of most REITs’ capital markets fundraising but they have barely been studied, until now. New research shows REIT bond spreads are not just generic corporate credit; they are explicitly priced off direct real estate performance and property type.¹

Unlike typical corporate bonds, REIT bonds are backed by a cash flow stream from rent, rather than a blend of owned corporate assets and sales. That makes REIT bondholders highly sensitive to the income profile of the underlying real estate. Equity holders want safe distributions too but also expect asset appreciation, portfolio optimization and platform growth at the REIT level, things bondholders care less about. Bondholders’ limited set of concerns means small changes in the metrics they do care about can drive significant spread movement.

The new study of 33,857 REIT bond yield spreads from 2010–2022 finds that real estate-specific variables meaningfully shape pricing. Stronger property markets tighten spreads: a one-percentage-point gain in total return narrows spreads by about 16.5 basis points. The more valuable a REIT’s assets and prospects for rent growth, the lower the credit spread, no surprise. Interestingly, broader indicators including stock market performance and stock market volatility don’t matter much to REIT spreads.

But here’s a surprise: Diversification in a REIT’s asset base, which you’d suspect would be a virtue, in fact raises borrowing costs.

Yep, “most specialized REITs exhibit lower bond yield spreads than diversified REITs.” Why? The authors offer two explanations: First, investors may have more difficulty valuing a diversified asset base, an argument we did not find convincing. Second, diversified REITs wrestle with more “management complexity and costs,” which is fair but high-performing private real estate investment firms do that routinely and to a much greater degree than diversified REITs. The better answer: Investors want to diversify their own portfolios, not have REIT managers do it for them. They want targeted exposures. Diversified REITs are thus less attractive - all else equal - to equity and bond investors alike.

So it’s better from a bond pricing perspective to be a one-property-type pony, but not all specialists are rewarded equally. Specialty REITs focused on core product types, see significantly tighter credit spreads than diversified REITs. However, infrastructure, data centers and lodging/resorts pay the highest spreads in the REIT world. The paper did not speak to why that might be, and we see good reasons for high spreads with data centers and with hospitality, but infrastructure was a puzzler. This is a good subject for more research.

Besides having favorite product types, the bond market also rewards scale. Larger REITs enjoy spreads roughly 86 basis points tighter than smaller peers. Bigger balance sheets mean less perceived default risk and better market access. Other key spread drivers included the bond’s coupon rate and maturity date: Higher coupons and longer durations increase the spread. Those two facts are to be expected: higher-coupon bonds are typically less liquid and generate higher taxable income for investors, both of which have been shown to drive premiums. Long-dated maturities add term risk and suffer from lower liquidity as well.

If you’re thinking there might be REIT bond mispricings to take advantage of, first, we like how you think. Second, this research employed a machine learning algorithm with “state of the art explainable machine learning methods” to determine exactly what, and by how much, different factors explained what moves REIT bond yields. In other words, a “neural network that recognizes nonlinearity” should absolutely be helpful in finding market inefficiencies.

Finally, we applaud the researchers for suggesting smart next steps. They point to geographic diversification as one next frontier—suggesting that location-specific risk premia could hold further insights into risk spreads for individual issuers. Yes please, we’d like to know more about that too.

The takeaway? REIT debt is priced according to real estate logic. Investors who understand the property-level fundamentals—asset type, scale, specialization, and perhaps soon geography—may be able to price risk precisely, maybe better than the market does, and the approach taken by these researchers could help those investors benefit. In a capital-constrained world, that's alpha.

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