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Near-Term Outlook for Retail REIT Stocks Appears Bright

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The Zacks REIT and Equity Trust - Retail industry represents a group of REITs that are engaged in owning, developing, managing and renting space in a variety of retail real estates. Among these retail real estate assets are regional malls, outlet centers, grocery-anchored shopping centers, as well as power centers which include big-box retailers. Furthermore, net lease REITs enjoy ownership of freestanding properties, wherein both rent and majority of operating expenses for the property are borne by the tenant.

Some of the prominent players in this industry are Simon Property Group SPG, Regency Centers Corporation REG, Federal Realty Investment Trust (FRT - Free Report) , Kimco Realty Corporation KIM and Macerich Company MAC.

Let’s take a look at the industry’s three major themes:

U.S. Economy and Consumer Spending: Strength of the economy, together with the job-market environment, plays a key role in shaping up the retail REIT industry’s performance, as these determine consumers’ spending capacity for buying retail goods and services. There are undoubtedly lingering issues for the economy, and retail store closures and bankruptcies are still grabbing headlines. Retail spending, however, is likely to remain healthy with a solid job market stimulating consumer spending. This is anticipated to send across positive ripple effects across the industry and help the retail real estate sector grow at a steady pace.

Omni-Channel Strategy: Purchase of retail goods and services takes place through multiple channels, playing a crucial part in determining the retail real estate space demand. In fact, e-commerce is gaining market share from the traditional brick-and-mortar stores, which is compelling retailers to reconsider their physical footprint and focus more on investing in online platforms.

While this has raised concerns over the fate of cash flows of physical stores and landlords, the latest trends suggest that even with the rising popularity of e-commerce, omni-channel will keep being the focal point for retailers, while physical stores will remain an integral and effective sales channel. This is because, despite choosing online retailing options, consumers still prefer exploring the option of visiting physical stores as well. Moreover, retail real estate landlords are embracing digitally-native brands and offering incentives, helping them open, operate and scale stores as a complement to e-commerce. Therefore, retailers focused on omni-channel models will likely navigate smoothly through the retail apocalypse, while REITs supporting their real estate needs will benefit.

Structural Changes to Continue: Amid changing consumer preferences, right-sizing of footprints and store closures will likely keep making it to front-page news, while the ones unable to cope with competition will resort to bankruptcy filing. Nevertheless, to counter these challenges and in an attempt to lure customers, retail REITs will continue with the transformation measures of their traditional retail hubs into entertainment destinations and lifestyle resorts. The REITs are likely to focus on expansion of dining options, opening movie theaters, as well as offer recreational facilities and fitness centers. Also, supply growth has been in check. Apart from these, focus on mixed-use development is anticipated to continue, which has gained immense popularity, of late, although with huge outlay for redevelopments, growth in profit margins of retail REITs in the near term may be affected.

Zacks Industry Rank Indicates Bright Prospects

The Zacks REIT and Equity Trust - Retail industry is housed within the broader Zacks Finance sector. It carries a Zacks Industry Rank #107, which places it at the top 42% 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 bright 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 top 50% of the Zacks-ranked industries is a result of positive funds from operations (FFO) per share outlook for the constituent companies in aggregate.

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

Industry Leads on Stock Market Performance

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

The industry has rallied 21.5% during this period compared with the S&P 500’s rise of 4.7%. During the same time frame, the broader Finance sector has inched up 1.2%.

One Year Price Performance

Industry’s Current Valuation

On the basis of forward 12-month price-to-FFO (funds from operations) ratio, which is a commonly used multiple for valuing Retail REITs, we see that the industry is currently trading at 15.18X compared with the S&P 500’s forward 12-month price-to-earnings (P/E) of 16.93X. However, the industry is trading above the Finance sector’s forward 12-month P/E of 13.88X. 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 19.44X, as low as 12.57X, with a median of 15.29X.

Bottom Line

In a nutshell, with a stellar job market and a resilient domestic economy, consumer spending is expected to remain upbeat and offer scope for growth to the retail REIT industry. Moreover, retail REITs’ concerted initiatives to boost retail assets’ productivity by trying to grab attention from new and productive tenants, and disposing the non-productive ones are commendable, despite significant outlays.

In addition to the above, REITs have improved their leverage level over the years. This looks encouraging for their operational efficiencies, as well as for investors, since interest expense may take a smaller bite out of REITs’ earnings. Consequently, dividend yields and profitability for investors are predicted to improve.

Therefore, as REITs strive to bring their mojo back, we handpick three stocks from the industry with a favorable Zacks Rank that will add Midas touch to your portfolio.

Acadia Realty Trust AKR: This REIT is engaged in operation, management, leasing, revamp, and acquisition of shopping centers and mixed-use properties with retail constituents. It is focused on building a core real estate portfolio with significant concentrations of assets in the dynamic urban and street-retail corridors of the nation. The stock holds a Zacks Rank of 2 (Buy), at present.  The Zacks Consensus Estimate for the ongoing year’s FFO per share has been revised marginally upward over the last 90 days. The FFO per share figure for 2019 also indicates a projected increase of 5.2%, year on year.

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

Realty Income Corporation O: The REIT is engaged in acquisition and management of freestanding commercial properties that generate rental revenues under long-term net lease agreements. It derives more than 90% of its annualized retail rental revenues from tenants belonging to service, non-discretionary and low-price retail businesses. Such businesses are less susceptible to economic recessions, as well as competition from Internet retailing. Along with its well-known commercial tenants, investors might love the fact that the firm pays a monthly dividend. This Zacks #2 Ranked company’s current-year FFO per share consensus estimate of $3.29 indicates a projected year-over-year increase of 3.1%. In addition, its 2020 FFO per share will likely witness year-over-year improvement of 7%.

Retail Properties of America, Inc. RPAI: This retail REIT is engaged in owning and operating premium open-air shopping centers that are strategically located, as well as properties with a mixed-use component. It currently carries a Zacks Rank of 2. The Zacks Consensus Estimate for the ongoing year’s FFO per share has been revised marginally upward over the last 60 days. In fact, the Zacks Consensus Estimate for the FFO per share is projected to be up roughly 1.9% and 2.7%, respectively, in 2019 and 2020.

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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