The Federal Reserve didn’t raise interest rates at the latest FOMC meeting. But with inflation nearing its target 2% mark, the market expects the central bank to stay the course and raise rates at least two more times this year and three times next.
This seemingly hawkish Fed stance would typically be a negative backdrop for REITs, but the space appears to have done adequate preparation for this monetary policy tightening cycle. Stronger balance sheets, fixed rate borrowings and extended maturities are some of the notable features that are giving REITs the flexibility to operate in the current environment. This financial flexibility is encouraging down the line for their operational efficiencies.
Moreover, high consumer confidence in an improving economy and job market gains are fueling consumption levels. In fact, with one eventually requiring “real space” for economic activities, prospects of the real estate sector are getting a boost as growth in the economy translates into greater demand for real estate and higher occupancy levels.
Further, valuation-wise, several REIT stocks seem attractive, while encouraging performance by a number of REITs in Q1 as well as an increase in merger and acquisition activities in the industry point at the prevailing favorable environment. Further with the inflation level creeping up, one must keep in mind that REIT dividend growth has surpassed inflation (as measured by Consumer Price Index), in 18 of the past 20 years.
All these provide enough incentive to investors to delve into the fundamentals of the individual asset segment of the REIT industry.
Industrial REITs are indeed firing on all cylinders, and per a study by the commercial real estate services firm CBRE Group Inc. (CBRE - Free Report) , availability fell for 31 straight quarters to 7.3% for the U.S. industrial market in first-quarter 2018. Moreover, with demand surpassing new supply, net asking rents climbed 1.9% in Q1 to $7.01 per square feet, denoting the highest level since 1989.
In fact, to support e-commerce business, address a large customer base and urbanization, companies are being compelled to enhance and renovate their distribution and production platforms. Services like same-day delivery are gaining traction, propelling demand for modern distribution facilities. Also, last-mile properties are witnessing a solid increase in asset values.
Going forward, with a recovering economy and job market gains as well as tax reforms, consumption levels are anticipated to remain elevated. And with a healthy manufacturing environment and high business inventories, demand for warehouse and logistics real estate is anticipated to be high.
Data Center, Cell Tower REITs
In addition to industrial REITs, e-commerce is also driving demand for data center and cell tower REITs. This is because, when demand is placed through smartphones, tablets or computers, the order is transmitted through cell towers and processed at data centers. In fact, without the offering of this critical infrastructure, the e-commerce value chain simply cannot sustain and therefore REITs, which happen to own many of these cell towers and data centers, are expected to benefit substantially.
Along with making purchases online, an increasing number of people are consuming digital content. Estimated growth rate for the markets of artificial intelligence, Internet of Things, autonomous vehicle and virtual/augmented reality are also anticipated to remain robust over the next five to eight years. In addition, the deployment of 5G network should drive growth of tower and fiber business as wireless carriers look to expand and enhance their networks. Therefore, along with an improved outlook for economic growth, all these only make us hugely optimistic about extensive growth in demand for space at cell tower and data-center REITs.
Despite several preeminent retail bankruptcy filings and record-high defaults by retail corporates, recent data from Reis, which Reuters had cited, shows that U.S. retail real estate vacancies was 10% in the first quarter of 2018 -- unchanged for the fourth consecutive quarter. Admittedly, consumer confidence is still high. Moreover, the stability clearly reflects the benefit from concerted efforts of the retail landlords to boost productivity of retail assets by trying to grab attention from new and productive tenants and disposing the non-productive ones. Also, with limited retail supply, refurbishment of existing properties is gaining traction.
Retail REITs are now avoiding heavy dependence on apparel and accessories, and rather expanding dining options, opening movie theaters, offering recreational facilities and opening fitness centers in particular. Also, amid the changing landscape in the retail real estate market, prime properties continue to enjoy strong demand, though class B and lower properties are experiencing a decline in occupancies. With the recent tax overhaul likely to benefit wages, consumer confidence and consumption levels, demand for prime properties is anticipated to remain strong in the rest of the year.
In the national apartment market, despite high supply and a seasonally slow first-quarter leasing period, thanks to the cold weather that inhibits shift of households, the occupancy level remained elevated and came in at 94.5% this March, just a notch lower than the prior-year tally of 95%, per the latest report from the real estate technology and analytics firm RealPage, Inc. (RP - Free Report) .
Moreover, solid job growth in recent months indicates more household formations and raises expectations for still healthy apartment market occupancy despite high deliveries in the near term. Also, shortages of construction labor and rising expenses might somewhat impede the growth momentum of supply.
Student Housing REITs
For student housing real estate market, there is stability in performance per a report by RealPage. Specifically, an increasing number of giveaways being offered and proximity to campus are aiding the healthy leasing volumes of this sector. Nonetheless, this sector has witnessed slight moderation in rent growth.
In fact, with a significant salary differential between college graduates and high-school graduates, college enrolment is set to increase. This will likely drive demand for residential units that are leased by student housing REITs. Also, demand is emanating for on-campus developments from universities that are facing state budget cuts and low funds. And on-campus housing usually enjoys full occupancy.
In the office sector too, though supply of new office space has slightly pushed up vacancy levels (by 20 bps) to 13.3% in Q1, per a CBRE Group data, demand for high-quality, efficient space remains strong. This is indicated by the pre-leasing of around 70% of space being delivered in Q1.
While higher construction with increased completions might moderate the pace of growth in the primary markets, suburban markets are likely to excel with increased population and growth in employment. Per the data from CBRE Group, for the fifth straight quarter, annual rent growth in suburban markets (2.3%) surpassed that of the downtown markets (0.2%).
In case of hotel REITs too, an improving economy, growth in employment and rise in wages are likely to drive demand for hotels. Particularly, improved business travel demand with lower cancellations and higher group spends, plus strong demand from leisure division signal better prospects for hotel REITs.
Mixed-use developments have gained immense popularity in recent years. Such developments lower the distance between housing, workplaces, retail businesses, and other amenities and destinations. Hence, such developments 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 United States. In recent years, retail REITs like Regency Centers Corp. (REG - Free Report) and Federal Realty Investment Trust (FRT - Free Report) also directed their investments toward such projects.
Demand for healthcare real estate is expected to increase considerably on favorable demographics. This is because the senior citizen population is growing at a faster rate than other adults, calling for a greater healthcare needs. Along with an aging population and cost containment, less expensive delivery settings and new technologies, demand for medical office buildings, outpatient facilities as well as urgent-care facilities is growing.
Moreover, university-based life science real estate has grabbed attention. In fact, increasing longevity of the aging U.S. population, along with biopharma drug development growth opportunities, have promoted institutional life science and medical-market fundamentals. Further, long-lease terms and top-rated, institutional quality tenants assure steady growth in cash flows for health care landlords.
Stocks to Add to Your Portfolio
Specific REITs that we prefer include Chatham Lodging Trust (CLDT - Free Report) , New Residential Investment Corp. (NRZ - Free Report) , Sun Communities, Inc. (SUI - Free Report) and Urstadt Biddle Properties Inc. (UBA - Free Report) .
Headquartered in New York, New Residential Investment Corp. focuses on investing in, and actively managing, investments related to residential real estate. The company primarily targets investments in mortgage servicing related assets, non-Agency securities and other related opportunistic investments. The stock has a Zacks Rank #1 (Strong Buy). It has experienced solid estimate revisions with the Zacks Consensus Estimate for 2018 and 2019 being revised 4.6% and 10.6%, respectively, in a month’s time.
West Palm Beach, FL-based Chatham Lodging Trust is focused mainly on investing in premium-branded upscale extended-stay and select-service hotels. It has a Zacks Rank of 2 (Buy). The stock has seen the Zacks Consensus Estimate for 2018 and 2019 being revised 1% and 2.6% upward in a week’s time.
You can see the complete list of today’s Zacks #1 Rank stocks here.
Southfield, MI-based Sun Communities is engaged in ownership, operation or enjoys stake in manufactured housing and recreational vehicle communities located in 29 states throughout the United States and Ontario, Canada. The stock has a Zacks Rank of 2. Moreover, it has a long term growth rate of 6.3%.
Greenwich, CT-based Urstadt Biddle Properties provides investors with an investment vehicle for participating in ownership of income-producing properties. Their core properties consist principally of community shopping centers located in the northeast. It has a Zacks Rank of 2 and a long-term growth rate of 8%, which is well above the industry average of 5.4%.
Check out our latest REIT Industry Outlook here for more on the current state of affairs in this market from an earnings perspective.
Note: Anything related to earnings presented in this write-up represent funds from operations (FFO) — a widely used metric to gauge the performance of REITs.
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