While some in the investment community have soured on real estate investment trusts — turned off by the Federal Reserve’s interest-rate hikes and the likelihood that real estate is late in its growth cycle — others still see value in the sector.
“REITs trade at a 10 percent discount to the private market value of their assets in an environment where real estate values are growing and yields are 4 percent,” says Scott Crowe, chief investment strategist at CenterSquare Investment Management, a real estate investment subsidiary of BNY Mellon. “There are a lot of opportunities, but they are more nuanced now. The trick is not to call the end of the real estate cycle, but to determine what’s happening under the surface.”
He and others aren’t too concerned about the Fed’s rate increases. That’s because long-term yields aren’t rising, which is more important to the real estate market, as most property-related debt is long term. The ten-year Treasury yield slid from 2.3 percent when the Fed first lifted rates in December 2015 to 2.15 percent by June 23. “That makes real estate more attractive,” Crowe says. “That’s why we see real estate prices holding up.” (The MSCI U.S. REIT Index was up 2.1 percent year-to-date as of June 23.)
Meanwhile, the real estate growth cycle can continue for several years because it has been so moderate, Crowe argues. GDP has expanded just more than 2 percent annually since the recession ended in 2009, well below the pace of normal recoveries. And inflation has generally stayed below 2 percent.
In the real estate market, REIT loan-to-value ratios stand at 30 percent now, compared to 50 percent prior to the financial crisis, Crowe says. “Because of the financial crisis, people are risk-averse,” he says. “It’s hard to get money to build assets, so there’s not a lot of imbalances in the market. As a result, we don’t expect the cycle will end anytime soon.”
Trying to gauge cycles is tricky in any case. “You don’t know exactly where we are in a cycle until the cycle is over for a year or so,” says Cedrik Lachance, director of U.S. REIT research for Green Street Advisors, a real estate research firm in Newport Beach, California.
The surge of online shopping has helped hammer retail-related real estate, with mall REITs registering a negative 20 percent return for the first five months of the year, and shopping-center REITs negative 15 percent, according to FTSE NAREIT.
But some see that drop as a buying opportunity. The retail rout “is completely overdone,” says Alexander Goldfarb, senior REIT analyst at investment bank Sandler O’Neill & Partners. He notes that the internet accounted for only 8.5 percent of retail sales in the first quarter, according to the Commerce Department. “Any quality shopping center or mall is full,” he says.
While plenty of retailers are closing stores, such as Macy’s and Sears, others, such as TJX Cos.’ T.J. Maxx and Marshalls, are thriving, he points out. “TJX isn’t successful because of its online presence, but because it has exciting merchandising.”
Lululemon, Tesla, Apple, and Microsoft are all companies that can sell online, but are opening physical stores at malls and can boost the malls’ sales substantially, Goldfarb says. He likes Simon Property Group, a mall REIT, and Brixmor Property Group, a shopping-center REIT. They both have occupancy rates above 90 percent and solid income growth, Goldfarb says. “If you’re a value investor, it’s hard to look anywhere else but retail,” he says.
Several analysts and money managers recommend apartment REITs in light of the declining homeownership rate and the trend toward urbanization. The homeownership rate stood at 63.6 percent in the first quarter, according to the Commerce Department, down from a peak of 69.2 percent in 2004. While increasing apartment supply has been a concern, that supply growth has started to decelerate, analysts say. “By 2019 there will be a lot less supply,” says Green Street’s Lachance.
Green Street is also attracted to manufactured-home (trailer-park) REITs. That’s because, like apartments, these properties require low capital reinvestment and tend to provide strong long-term cash flow. And virtually no new supply is coming into the sector, Lachance says.
While the growth in online commerce is decimating the retail sector, it’s creating a need for more warehouse storage and distribution space, notes Steven Brown, senior portfolio manager at American Century Investments. That’s good news for Prologis, an industrial REIT, he says. Brown also recommends data-center REITs, such as Digital Realty, that are benefiting from the surge in wireless and online activity. The strength of the life-science sector makes REITs in that area appealing, Brown says, citing Alexandria Real Estate Equities.
Martin Fridson, chief investment officer at money management firm Lehmann Livian Fridson Advisors in New York, is playing the growth in wireless communications through cellphone-tower REITs. Another sector he’s bullish on: assisted-living-facility REITs. “Demographics mean more demand for assisted living,” he says.
