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Key Reasons for Optimism on REITs

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Rising interest rates, treasury yields and supply increases in certain asset categories made investors jittery in recent months. But these were not enough to overshadow the REIT industry’s growing importance over the years.

In fact, the U.S. REIT market has continued to expand with the FTSE NAREIT All REITs Index, comprising 224 REITs with a combined equity market capitalization of $1.073 trillion, ahead of 219 REITs and $972 billion in equity market capitalization at the end of April 2016. Further, the creation of the exclusive headline sector for real estate under the GICS last year raised expectations of drawing in billions and pushing up valuations over time.

Further, $23.11 billion in capital raised in equity and debt during first-quarter 2017 by publicly listed REITs set a 3-year record per the recent report. This indicates investors' faith in this sector and their willingness to pour money into it.

Also, with a number of asset categories revealing strength and the REITs catering to those with solid returns, at times above broader market, the time is now apt to explore the industry in depth and scoop up big gains.

Data Center REITs

With growth in cloud computing, Internet of Things and Big Data, and an increasing number of companies opting for third-party IT infrastructure, data center REITs are experiencing a boom market. In fact, demand is outpacing supply in top-tier data center markets, and despite enjoying high occupancy, these are absorbing new construction at a faster pace.

Additionally, according to a Cisco forecast, global “data center-to-data center” IP traffic is expected to witness a compound annual growth rate of 32% over the 2015–2020 period. Further, per Gartner reports, worldwide IT spending growth is projected to increase 3.3%, while worldwide server shipments are expected to rise 4.6% in 2017. This, along with an improved outlook for economic growth, is anticipated to drive demand for data centers. In fact, data center REITs pulled in their capital and scored well on the return book through April 2017, registering total returns of 18.03%.

Industrial REIT

In the industrial real estate market, demand for space has been high for several quarters. In fact, the overall U.S. industrial real estate market also remained upbeat in first-quarter 2017 despite increased supply. Per a NAREIT media release, Industrial REITs delivered solid same-store NOI growth of 5.9% in the first quarter of 2017.

As a matter of fact, amid economic expansion, an e-commerce boom and heightened urbanization, companies are shifting their strategy toward services like same-day delivery, propelling demand for warehouse distribution facilities. In fact, per a report from Prologis Inc. (PLD - Free Report) , for a given level of revenue, online retailers require three times the distribution center space compared with traditional retailers. This is creating scope for industrial REITs like Prologis, DCT Industrial Trust Inc. (DCT - Free Report) and Liberty Property Trust (LPT - Free Report) to flourish. 

Further, the construction of mega industrial houses, spanning 1 million square feet or more, is rampant in large industrial markets, according to another report from CBRE Group. Around 90 million square feet of these mega facilities, which benefit from growing e-commerce business, have been accomplished since 2010 in the top 10 markets; while an additional 31.6 million square feet is under construction, with 60% pre-commitments, displaying solid demand for such facilities.

Office REIT

Office REITs are experiencing decent demand in recent times. In fact, though the overall office vacancy rate moved up a modest 10 basis points to 13.0% in first-quarter 2017 amid increased supply, according to a report from CBRE, in almost half of the office markets, vacancy level continued to fall and the national office vacancy rate stayed close to its post-recession low. Going forward, with economic improvement and recovery in the job market, demand for office space is expected to shoot up.

Residential REIT

Admittedly, rising supply is a growing concern in the apartment market, particularly in the high end and luxury apartment categories. But increasing consumer confidence on the back of job growth, rising wages and a healthier balance sheet promise a bright future for this asset category. Additionally, corporate profits are up and business confidence has recovered. Also, construction labor shortages have somewhat helped the industry witness comparatively lesser supply than anticipated in the first few months of 2017.

Further, demographic growth continues to be strong in the young-adult age cohort, which has a higher propensity to rent. In fact, a significant change in lifestyle has taken place and life cycle events are getting delayed. This is leading to an increase of the average age of first-time homeownership. This age cohort has also experienced a considerable part of net job growth, and is helping to increase primary renter demand.

Moreover, student housing REITs are expected to enjoy growth ahead. This is because, with a higher education earnings gap – millennials with a high school diploma are earning just 62% of what college graduates are making – college enrollment is set to increase and this would drive up demand of residential units that student REITs lease. Also, there is pent-up demand for new, purpose-built student housing properties that have better amenities than old, outdated housing.

Further, student housing REITs have decent opportunities to excel in the coming years as demand is emanating for on-campus developments from universities that are facing state budget cuts and low funds, and are incapable of developing or renovating their aging housing properties. And on-campus housing usually enjoys full occupancy.

Retail REIT

Obviously, dwindling mall traffic and store closures amid the online sales boom as well as bankruptcy filing of retailers have kept retail REITs on tenterhooks. Amid the ongoing changes in consumer behavior, retail REITs are avoiding heavy dependence on apparel and accessories and are transforming their boring shopping hubs into swanky entertainment zones. They are expanding dining options, opening up movie theaters and offering recreational facilities. Eventually, such measures are likely to help in increasing traffic.

Retail REITs also prefer expansion of shops, which comprise service-based industries such as saloons and spas, personal fitness, and medical practices. Such properties enjoy frequent customer traffic and are Internet-resistant, and therefore drive a dependable traffic.

Also, mixed-use developments have gained popularity for their solid neighborhood character, greater housing variety and density. Such developments lower the distance between housing, workplaces, retail businesses, and other amenities and destinations. Hence, such development enable companies to grab the attention of people who prefer to live, work and play in the same area – a trend that drove development in several other cities in the U.S.

Therefore to explore these positives of mixed-use developments, REITs like AvalonBay Communities Inc. (AVB - Free Report) and Regency Centers Corp. (REG - Free Report) went for the Market Common Clarendon. Also, Mack-Cali Realty Corp. (CLI - Free Report) is focused on transforming itself through waterfront and transit-based office holdings, and on luxury multi-family portfolio growth, which is encouraging.

Stocks to Add to Your Portfolio

Specific REITs that we prefer include Equity LifeStyle Properties, Inc. (ELS - Free Report) , Sunstone Hotel Investors, Inc. (SHO - Free Report) , Gladstone Land Corp. (LAND - Free Report) and AGNC Investment Corp. (AGNC - Free Report) .

Equity LifeStyle Properties is a residential REIT engaged in the ownership and operation of manufactured home communities, RV resorts and campgrounds in North America.Equity LifeStyle Properties has a long-term growth rate of 4.7%. It has a Zacks Rank #2 (Buy) and has exceeded estimates in the three of the trailing four quarters with an average beat of 1.16%. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Sunstone Hotel is a lodging REIT that has a portfolio of hotels which are mainly in the upper upscale segment. It is a steady performer, having surpassed the Zacks Consensus Estimate in the trailing four quarters, with an average surprise of 11.7%. It has a Zacks Rank #2. Also, its estimates for 2017 have been moving north over the past 30 days.

Gladstone Land Corp. is a REIT that specializes in acquiring farms and farm-related properties and leasing them to farmers. It has a Zacks Rank #2 and its estimates for 2017 have moved north over the past two months. The stock is also trading at a discount to the industry average.

AGNC Investment Corp. is an internally-managed real estate investment trust. It invests in agency mortgage-backed securities on a leveraged basis, financed primarily through collateralized borrowings structured as repurchase agreements. It has a Zacks Rank #2 and has exceeded the Zacks Consensus Estimate in each of the trailing four quarters with an average beat of 10.8%. Also, its estimates for 2017 have moved north over the past one month.

Check out our latest REIT Industry Outlook here for more on the current state of affairs in this market from an earnings perspective.

Note: All EPS numbers presented in this write up represent funds from operations (“FFO”) per share. FFO, a widely used metric to gauge the performance of REITs, is obtained after adding depreciation and amortization and other non-cash expenses to net income.

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