REIT as an Asset Class
A Real Estate Investment Trust (REIT) is a company that owns and
manages income-producing real estate such as apartments, offices,
hotels, industrial or other facilities. Such companies also invest
in mortgages or mortgage-backed securities attached with
properties. REIT shareholders enjoy ownership benefits of the real
estate without actually becoming landlords.
This hybrid asset class offers capital appreciation along with
yield, thereby adding diversity to ones equity portfolio and
assuring competitive long-term returns. It also provides a hedge
against inflation.
Industry Performance So Far This Year
The U.S REIT industry has been on a roller coaster so far this
year. After a remarkable run in the first four months, the sector
nosedived in May, as rising interest rates and skepticism about the
Fed’s Quantitative Easing (QE) program spread caution in the
market. The apprehensions spilled over to August.
But around mid-September, the REIT stage was again set for action
with the Fed’s ‘no taper’ decision and lower GDP projections for
2013 and 2014, which indicated a continued low interest rate
environment in the near term.
As a result, the REIT stocks rallied the most and outperformed the
S&P 500. On a total return basis, the broadest U.S. REIT Index
-- FTSE/NAREIT All REIT Index -- gained 3.55%, outpacing 3.14%
growth for the S&P 500 in September. Further, in October (as of
24th of the month), FTSE/NAREIT All REIT Index return gained pace
and came in at 6.13%, compared to 4.31% growth for the S&P
500.
However, over the first nine months of 2013, REITs have
underperformed the broad market. Total return of the FTSE NAREIT
All REITs Index was up only 2.89% compared to the increase of
19.79% for the S&P 500. Notably, the FTSE NAREIT All Equity
REITs Index moved north 3.03% while the FTSE NAREIT Mortgage REITs
Index dropped 2.11%.
Though the third-quarter 2013 earnings picture has improved in the
most recent week, we notice that the guidance still remains on the
weak side, leading to negative estimate revisions at a majority of
the companies.
Amid such an environment and along with disappointing government
job reports, we hope that the Fed’s QE program will continue for a
period more than previously anticipated. This should keep the
demand for high-dividend-paying REIT stocks alive.
Dividends Are Key Attraction
The U.S. law requires REITs to distribute 90% of their annual
taxable income in the form of dividends to shareholders.
Yield-hungry investors thus have a large appetite for such stocks.
This has enabled the industry to stand out and gain a footing over
the last 15–20 years.
As of Sep 30, 2013, the dividend yield of the FTSE NAREIT All REITs
Index was 4.34%. The yield of the FTSE NAREIT All Equity REITs
Index was 3.68% while the FTSE NAREIT Mortgage REITs Index
delivered a dividend yield of 11.33%. Clearly, the REITs continued
to offer solid yields and outpaced the 2.14% dividend yield offered
by the S&P 500 as of Sep 30.
Capital Access
Accessibility to capital is a prime factor in the REIT industry.
After raising $51.3 billion capital in 2011 and a total of $73.3
billion in 2012, REITs raised $60.6 billion in the first nine
months of 2013. A solid IPO market in 2013 primarily made it
happen.
In the first three quarters, REITs raised $3.08 billion through 14
IPOs that comfortably surpassed the $1.82 billion capital infusion
through 8 IPOs in 2012. The third quarter has been the most active
one with around $1.25 billion raised from 4 IPO offerings.
During the latest downturn, REITs were able to acquire premium
properties from highly leveraged investors at heavy discounts.
Furthermore, REITs typically have a large unencumbered pool of
assets, which could provide an additional avenue to raise cash
during crisis.
These assets, in turn, have provided the requisite wherewithal to
the REIT industry to grow through strategic acquisitions over time.
Moreover, the financing for sound properties is currently abundant
as willing commercial real estate lenders continue to extend
lending.
Zacks Industry Rank
Within the Zacks Industry classification, REITs are broadly grouped
into the Finance sector (one of 16 Zacks sectors) and further
sub-divided into four industries at the expanded level: REIT Equity
Trust - RETAIL, REIT Equity Trust - Residential, REIT Equity Trust
- Other and REIT Mortgage Trust.
We rank all 259 industries in the 16 Zacks sectors based on the
earnings outlook and fundamental strength of the constituent
companies in each industry. This ranking is available in the Zacks
Industry Rank page.
http://www.zacks.com/zrank/about_ind_rank.php
As a point of reference, the outlook for industries with Zacks
Industry Rank #88 and lower is 'Positive,' between #89 and #176 is
'Neutral' and #177 and higher is 'Negative.'
The Zacks Industry Rank for REIT Equity Trust - Other is #81, REIT
Equity Trust - Retail is #104, REIT Mortgage Trust is #105 and REIT
Equity Trust - Residential is #177. Analyzing the Zacks Industry
Rank for different REIT segments, it is obvious that while the
outlook for REIT equity trust – other remain at the low end of the
positive range, the rest of the industries – mortgage trusts,
residential equity trusts and retail equity trusts are in the
neutral zone.
Earnings Trends
Currently, we are into the heart of third quarter 2013 earnings
season with results from nearly half of the S&P 500 companies
already declared.
The broader Finance sector, of which REITs are part, has been less
of a growth contributor this quarter. Results by industry behemoths
like
JPMorgan Chase & Co. (JPM) and
The Goldman Sachs Group, Inc. (GS) were not
impressive and the growth momentum has slowed over the quarters.
But the majority of S&P 500 REITs are yet to report their
earnings.
Among the finance companies that have already reported, the
‘earnings beat ratio’ (percentage of companies with positive
surprises) was 56.4% while the ‘revenue beat ratio’ was 43.6%.
Total earnings for this sector were up 13.0% year over year,
moderating from the 36.0% growth in the second quarter. Total
revenue moved south 1.0% verses 8.9% growth in the prior
quarter.
Looking at the consensus earnings expectations for the rest of the
year, we are encouraged by the estimated 12.2% growth for the third
quarter and 32.8% for the fourth, implying full-year 2013 growth of
13.3%.
For a detailed look at the earnings outlook for this sector and
others, please read our Earnings Trend report.
OPPORTUNITIES
REIT Equity Trust - Other
This is a diversified group of REIT companies and notable segments
in it are as follows:
Industrial/Storage REITs: With a larger customer base,
rise in e-Commerce application and supply chain consolidation, the
demand for logistics infrastructure and efficient distribution
networks has grown.
Hence, these REITs that own or manage properties for industrial
needs such as bulk warehouses, self-storage facilities,
distribution facilities, and light industrial facilities, are
enjoying a favorable trend in U.S. industrial absorption. As such,
stocks like
CubeSmart (CUBE),
Extra Space
Storage Inc. (EXR),
Public Storage (PSA)
and
Sovran Self Storage Inc. (SSS) look
promising.
Lodging/Resorts REITs: With improving U.S. business and
strong international travel and tourism volumes, the lodging sector
is expected to remain in the recovery path. Pricing in this
industry is anticipated to rise on limited supply and rising
demands. Stocks worth a look include
Sotherly Hotels
Inc. (SOHO),
LaSalle Hotel Properties
(LHO) and
Sunstone Hotel Investors Inc. (SHO).
Healthcare REIT: These REITs are likely to benefit from
the projected 7.4% rise in national health expenditures in 2014,
according to Centers for Medicare and Medicaid Services. Also, the
federal agency projects health expenditures to see compounded
annual growth rate of 6.2% over 2015 through 2021.
Though the forthcoming wave of retiring baby boomers is often cited
as a threat to the U.S. economy, this is a boon for the healthcare
sector as senior citizens spend 200% more than the average
population. Moreover, the Affordable Care Act would substantially
raise new insured individuals thereby raising the demand not just
for healthcare facilities, but also for properties offered by
healthcare REITs. In particular, the demand for medical office
buildings is expected to get a boost.
We foresee Healthcare REITs like
HCP Inc. (HCP)
and
Ventas Inc. (VTR) capitalizing on this
trend.
However, in the near- to mid-term, increasing supply in senior
housing would lower the growth in rent and occupancy to some
extent. Moreover, the skilled nursing facilities category
would continue to bear the risk associated with government
reimbursements.
REIT Mortgage Trust
In the past couple of years, with low short-term rates and QE
policies, mortgage REITs (commonly known as mREITs) have benefited
from lower borrowing costs, leading to higher yields. Notably,
mortgage REITs invest in mortgage-backed securities and use
short-term debt for financing their purchases to make money from
the spread.
Amid increasing yields on the U.S. Treasury 10-year note and
apprehensions of the Fed’s pulling out its QE program, mREITs
stocks tumbled in May. But in September, the ‘no taper’
announcement curtailed growth projections by the Fed and a
lackluster employment scenario implied a continued low interest
rate environment which would support the mREITs.
We believe this favorable environment will continue in the near
term and support stocks like
AG Mortgage Investment Trust
Inc. (MITT),
Apollo Commercial Real Estate Finance
Inc. (ARI),
CYS Investments, Inc. (CYS)
and
ZAIS Financial Corp. (ZFC). However, we are
somewhat skeptical about the long-term prospects of their
business.
REIT Equity Trust - Residential
The demographic growth continues to be strong in the young adult
age cohort, or those under age 35, who have a higher propensity to
rent. In fact, with the lack of stability in the job market and
mounting student debt, home ownership in the under-35 age cohort
continues to decline.
Moreover, with stringent mortgage underwriting standards amid new
banking regulations, renting has emerged as the only viable option
for those who cannot avail of mortgage loans.
This makes us positive on stocks like
Post Properties
Inc. (PPS),
American Residential Properties
Inc. (ARPI) and
BRE Properties Inc.
(BRE).
But with a considerable number of projects nearing completion, we
expect supply to increase in the near term. This could slow down
rent growth as more companies seek occupancy. However, new starts
are likely to be pushed back amid rising construction costs and
interest expenses.
WEAKNESSES
Continued low interest rate environment amid protracted economic
recovery is good news for the REIT sector. But we believe that the
current macroeconomic environment is problematic for the following
segments.
REIT Equity Trust - Retail
Since the start of the third quarter, the Retail sector suffered
substantial negative estimate revision. We predict thwarted tenant
sales in the near term due to tepid economic recovery with weak
consumer confidence and a soft job market.
Despite this economic uneasiness, we believe retail properties such
as strip centers, housing stores selling grocery items, drugs and
other necessary stuff for regular use by the local neighborhood,
will perform better than the regional malls in the near term.
In fact, during times of economic slump, the grocery-anchored
shopping centers have earned the reputation of putting up a
consistent performance and therefore we are bullish on stocks like
Cedar Realty Trust, Inc. (CDR) and
Regency
Centers Corporation (REG) that have exposure to these
properties.
Barring these, we would rather avoid other mall-based REITs like
Glimcher Realty Trust (GRT) and
Taubman
Centers, Inc. (TCO) in the near term.
Though improvements have been noticed in some of the office markets
of late, we still find the U.S. economy weighed down by sluggish
growth with uninspiring employment data and soft demand for office
properties. Conditions remain choppy for the Washington, D.C.
office market, with slow leasing activities and weak rental
rate.
Also, we note that companies like
Mack-Cali Realty
Corp. (CLI) have started to trim their office properties
and diversify into the relatively stable multifamily apartment
sector.
Conclusion
Macroeconomic issues and political drama have created tension in
the market. Yet we foresee improved rents and occupancies as the
economic recovery gains momentum. In fact, we believe that rising
interest rates should not always be seen as a headwind to REIT
stocks. Notably, interest rates move north when the economy gains
strength and this, in general, drives demand for properties offered
by REITs.
Also, we note that during the 40-year period from 1972 to 2012,
average annual total returns for REITs were 8.09%, while the
average annual market return was 13.72%. In addition, total returns
of equity REITs have consistently provided a hedge against
inflation. According to the data from Jan 1978 to Mar 2013, total
returns of equity REITs have either equaled or exceeded the
inflation rate in 67% of high-inflation six-month periods.
Data on average annual total returns from 1972 through 2012
illustrate the benefit of REITs’ steady income returns. While REIT
stocks have exhibited clear potential for strong price
appreciation, price returns can fluctuate from year to year. In
contrast, REITs have yielded a consistent annual income component
of 8.09 percent during that period, representing approximately 60
percent of the industry’s average annual total return of
approximately 13.72 percent.
So an opportunistic investment in REITs should not disappoint over
the long run.
APOLLO COMMERCL (ARI): Free Stock Analysis Report
AMERICAN RES PR (ARPI): Free Stock Analysis Report
BRE PROPERTIES (BRE): Free Stock Analysis Report
CEDAR SHOPN CTR (CDR): Free Stock Analysis Report
MACK CALI CORP (CLI): Free Stock Analysis Report
CUBESMART (CUBE): Free Stock Analysis Report
CYS INVESTMENTS (CYS): Free Stock Analysis Report
GLIMCHER REALTY (GRT): Free Stock Analysis Report
HCP INC (HCP): Free Stock Analysis Report
AG MORTGAGE INV (MITT): Free Stock Analysis Report
POST PPTYS INC (PPS): Free Stock Analysis Report
PUBLIC STORAGE (PSA): Free Stock Analysis Report
REGENCY CTRS CP (REG): Free Stock Analysis Report
SOVRAN SLF STOR (SSS): Free Stock Analysis Report
TAUBMAN CENTERS (TCO): Free Stock Analysis Report
VENTAS INC (VTR): Free Stock Analysis Report
ZAIS FINANCIAL (ZFC): Free Stock Analysis Report
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