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3 Equity REIT Stocks Poised to Escape Pandemic-Led Industry Weakness

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The pandemic-induced demand patterns and prevalent macroeconomic issues are hurting the REIT and Equity Trust - Other industry’s prospects. Moreover, investors’ sector rotation sentiments post-vaccine are creating hiccups.

However, with the industry offering the real estate structure for several economic activities, be it real or virtual, there are pockets of strengths even amid the pandemic-triggered industry weakness. Particularly, with healthy fundamentals of the digital economy, migration trends and life-science assets’ demand, Prologis (PLD - Free Report) , Extra Space Storage (EXR - Free Report) and Alexandria Real Estate Equities (ARE - Free Report) are likely to continue benefiting.

About the Industry

The Zacks REIT and Equity Trust - Other industry is a diversified group, covering REIT stocks from different asset classes like industrial, office, lodging, healthcare, self-storage, data centers, towers and others. The REITs rent spaces in these properties to tenants and earn rental incomes.

Along with the macroeconomic conditions, the performance of Equity REITs depends on the underlying asset dynamics and location of properties. Hence, delving into the fundamentals of those asset categories is all the more essential before making any investment decision. Also, it is highly important to figure out whether or not the pandemic-led behaviors will create only short-term impact or induce long-term structural changes.

What’s Shaping Future of the REIT and Equity Trust - Other Industry?

Fundamentals of REITs involving low levels of face-to-face interactions remain solid: It is no secret now how the pandemic and concerns about face-to-face contact prompted online interactions and purchases. This substantial shift from in-person communication and commerce to the electronic platform will continue helping sectors like industrial, infrastructure, and data centers to prosper in the foreseeable future. However, investors’ sector rotation sentiments post-vaccine and tech-driven sell-off might create hiccups. Moreover, the self-storage REITs continue to benefit as the pandemic-led movement of people and downsizing have resulted in increased demand for storage units, helping occupancy levels to reach fresh highs.

REITs having high potential exposure to infection to have a protracted recovery: The current pandemic environment is still challenging and hence, REITs that have high potential exposure to infection are likely to continue suffering. Hotel REITs are expected to continue being affected by the reduction in travel demand. While personal and vacation travel might recover and create demand for lodging spaces, particularly in markets that cater to domestic leisure travelers, business travel will likely be slower to recapture its lost ground, thanks to the online meetings and teleconferences substituting a number of in-person events. For office REITs, along with the overall economic turbulence and job losses, the remote-working wave has substantially affected demand for office spaces. Any material recovery will likely remain elusive until the vaccines become widely available, and help normal activities resume and workers return back to offices and safely reoccupy spaces. Therefore, in the near term, asking rents are likely to be affected amid soft tenant demand and increasing available spaces for leases. For healthcare REITs, demand for life-science real estate has been solid and will likely remain so with effective diagnostics, testing, therapies and vaccines being required to fight the pandemic. Nevertheless, there is still a strain on occupancy level and rate for senior housing assets.

Macroeconomic Issues, Soft Rental Demand and Rent Collection Woes: The real estate sector’s prospects get a boost when economy progresses. This is because growth in the economy translates into greater demand for real estate, higher occupancy levels and landlords’ power to ask for increased rents. While situations have improved compared to the earlier turbulent months, the rate of recovery is only likely to gain pace with widespread vaccinations, realization of the full impact of the fiscal stimulus and the economic recovery gaining steam. Therefore, the pace of recovery in the interim period is likely to remain sluggish. Amid this, rental demand for a number of asset categories will continue being soft, initial lease-up of new deliveries might be challenging in the days to come, and rent discounting as well as use of concessions will be rampant. Furthermore, amid protracted economic recovery, stress on tenants’ financial capacity might prevail and result in continuation of rent-collection issues. Hence, amid these, REITs with a better balance-sheet position and ample liquidity are well poised to sail and bank on the solid scopes.

Low Rate Environment: Nevertheless, Equity REITs will continue benefiting from the Fed’s low-rate stance because REITs depend on debt for business. Thus, these companies benefit from the lower borrowing costs in a low-rate environment. Additionally, low rates contribute to higher valuations. Further, REITs are often treated as bond substitutes for their high-dividend paying nature and in recent times a number of REITs have come up with dividend hikes. Moreover, REITs offer protection from inflation as both rents and valuations get a boost when prices flare up, in turn, supporting cash flows from their properties and driving dividend growth. Apart from this, Equity REITs have been proactive in the capital market in recent years. These companies have opportunistically used the low-rate environment to make their financials more flexible, which is encouraging down the line for REITs’ operational efficiencies.

Zacks Industry Rank Indicates Bleak Prospects

The Zacks REIT and Equity Trust - Other industry is housed within the broader Finance sector. It carries a Zacks Industry Rank #203, which places it at the bottom 20% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates bleak near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

The industry’s positioning in the bottom 50% of the Zacks-ranked industries is a result of the negative funds from operations (FFO) per share outlook for the constituent companies in aggregate. Looking at the aggregate FFO per share estimate revisions, it appears that analysts are losing confidence in this group’s growth potential. Over the past year, the industry’s FFO per share estimate for 2021 has moved 15.1% south.

Before we present a few stocks that you might want to consider for your portfolio, let’s take a look at the industry’s recent stock-market performance and valuation picture.

Industry Lags on Stock Market Performance

The REIT and Equity Trust - Other Industry has lagged both the S&P 500 composite as well as the broader Zacks Finance sector in a year’s time.

The industry has depreciated 2%, during this period, as against the S&P 500’s rally of 25.5%. Meanwhile, the broader Finance sector has gained 12.2%.

One-Year Price Performance

Industry’s Current Valuation

On the basis of the forward 12-month price-to-FFO ratio, which is a commonly-used multiple for valuing REIT - Others, we see that the industry is currently trading at 19.39X compared with the S&P 500’s forward 12-month price-to-earnings (P/E) of 22.02X. The industry is trading above the Finance sector’s forward 12-month P/E of 16.62X. This is shown in the chart below.

Forward 12 Month Price-to-FFO (P/FFO) Ratio

Over the last five years, the industry has traded as high as 19.56X, as low as 14.58X, with a median of 16.34X.

3 Equity REIT – Others Stocks to Keep a Close Eye on

Prologis: This leading industrial REIT focuses on industrial real estate space in high-barrier, high-growth markets. The company owns or has investments in, on a wholly-owned basis or through co-investment ventures, properties and development projects in 19 countries. Prologis’ better-than-expected performance in fourth-quarter 2020 was driven by decent growth in rental income. Recently, the REIT also announced an 8.6% hike in its quarterly dividend. Along with the fast adoption of e-commerce, logistics real estate is anticipated to gain from a likely rise in inventory levels and given Prologis’ capacity to offer high-quality facilities in key markets and robust balance-sheet strength, it is well poised to bank on these trends.

Prologis currently carries a Zacks Rank #3 (Hold). The Zacks Consensus Estimate for the 2021 and 2022 FFO per share moved 1.6% and 2.4% north to $3.92 and $4.31 over the past month, reflecting positive sentiments.The company’s shares have gained 2.4% over the past three months.

You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Alexandria Real Estate Equities: This urban office REIT particularly focuses on collaborative life-science, agtech and technology campuses in the AAA innovation cluster locations. The company has a considerable market presence in Greater Boston, San Francisco, New York City, San Diego, Seattle, Maryland, and Research Triangle. This Zacks Ranked #3 company’s fourth-quarter 2020 results highlight decent internal and external growth. The company witnessed continued healthy leasing activity and rental rate growth during the quarter.

Over the past month, the Zacks Consensus Estimate for 2021 and 2022 FFO per share has been revised upward to $7.73 and $8.24, respectively, calling for year-over-year growth of 5.9% and 6.6%. The stock has also rallied 1.2% over the past year.

Extra Space Storage: This self-storage REIT is the second largest owner and/or operator of self-storage stores in the United States. Furthermore, it is the largest self-storage management company in the nation. This Zacks #2 Ranked company is poised to benefit from stellar demand for self-storage units amid the pandemic, driven by the movement of people and downsizing. It delivered better-than-expected fourth-quarter results on strong average occupancy and higher average rates to existing customers for the quarter. Its acquisition, management and bridge loan pipelines are healthy.

The Zacks Consensus Estimate for the current-year FFO per share has been revised more than 2.5% upward over the past week to $5.66, indicating a year-on-year improvement of 7.2%. The stock has appreciated 14.5% over the past six months.

Note: Funds from operations (FFO) is a widely used metric to gauge the performance of REITs rather than net income as it indicates cash flow from their operations. FFO is obtained after adding depreciation and amortization to earnings and subtracting the gains on sales.

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