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Near-Term Outlook Bleak for Equity REIT Stocks

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The Zacks REIT and Equity Trust - Other industry is a diversified group, comprising REIT stocks from diverse asset classes, such as industrial, office, lodging, healthcare, self-storage, data centers and others.

Some prominent players in this industry are infrastructure REITs American Tower Corp. AMT, Crown Castle International CCI and SBA Communications Corp. (SBAC - Free Report) , industrial REIT Duke Realty Corporation DRE, healthcare REITs like Healthpeak Properties, Inc. (PEAK - Free Report) , Ventas, Inc. (VTR - Free Report) , and Welltower, Inc. (WELL - Free Report) , office REIT Alexandria Real Estate Equities, Inc. ARE, lodging REIT Host Hotels & Resorts (HST - Free Report) , self-storage REIT Public Storage (PSA - Free Report) and Extra Space Storage Inc. (EXR - Free Report) , data-center REITs Digital Realty Trust DLR and Equinix, Inc. (EQIX - Free Report) , diversified REIT Vornado Realty Trust (VNO - Free Report) , and specialty REIT Iron Mountain (IRM - Free Report) .

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

Technological evolution has been transforming the real estate market dynamics and substantially driving demand in a number of asset categories. The e-commerce boom, in particular, has significantly fueled demand for logistics facilities, besides backing cell towers and data centers. Further, rapid growth in cloud computing, Internet of Things and big data, and an increasing number of companies opting for third-party IT infrastructure are spurring demand for data-center REITs. Also, 5G network deployment has been benefiting tower REITs. Data-analytics expertise of self-storage REITs too are offering a competitive advantage. Apart from these, biopharma drug development growth opportunities amid increasing longevity of the aging U.S. population are boosting the institutional life-science and medical-market fundamentals.

Strength in economy and job market plays a key role in determining REITs’ performance. These factors determine the capacity of rent that can be shelled out. Resilient economic activity and healthy job-market environment are translating into elevated demand for real estate, leading to high occupancy levels and landlords’ greater power to command higher rents. For office REITs, the Sunbelt markets are likely to benefit from relocations of corporates and job growth. Moreover, easier capital availability and comparatively lower levels of interest rates keep the momentum upbeat for REITs, given their substantial dependence on debt and their consideration as a bond substitute for a high dividend-paying nature. Further, specialty sectors — self-storage, data centers, medical office, life sciences facilities and seniors housing — have made headlines in recent years, with investments in these alternative asset classes rising steadily. The aged population or the silver tsunami is shaping up healthcare REITs’ future, as this group has the largest customer base of healthcare services, spending more on such services than the average population, spurring demand for seniors housing assets, skilled nursing facilities and others.

Nevertheless, despite a decent economy and a healthy job-market environment, rising delivery of new units in several asset categories, such as industrial, office, senior housing and self-storage, has kept REITs on tenterhooks. Rising construction activities with increased completions is moderating landlords' ability to demand higher rents and boost occupancy levels, as well as resulting in high concessions. In the self-storage industry, growth might be limited thanks to the development boom in several markets, along with elevated marketing expenses and property taxes. Healthcare REITs too keep witnessing softness in seniors housing fundamentals as supply has shot up rapidly, of late, in this asset category, while labor costs are flaring up. In fact, with excess labor inflation amid tight labor market, margins are likely to be under pressure. Meanwhile, aggressive pricing pressure and substantial debt burden might limit data-center REITs’ growth tempo.

Zacks Industry Rank Indicates Bleak Prospects

The Zacks REIT and Equity Trust - Other industry is housed within the broader Zacks Finance sector. It carries a Zacks Industry Rank #171, which places it at the bottom 33% 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 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 2019 and 2020 moved down 4.7% and 13.2%, respectively.

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 Mixed on Stock Market Performance

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

The industry has rallied 12.3% during this period compared with the S&P 500’s rise of 17.5%. During the same time frame, the broader Finance sector has gained 6.3%.

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 REIT - Others, we see that the industry is currently trading at 18.13X compared to the S&P 500’s forward 12-month price-to-earnings (P/E) of 18.5X. The industry is trading above the Finance sector’s forward 12-month P/E of 14.49X. 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 18.85X, as low as 14.29X, with a median of 16.10X.

Bottom Line

In a nutshell, despite job-market growth, favorable demographics, technological developments and lifestyle transformations, the delivery boom in certain asset classes in the near- to mid-term might strain rental rates and result in high concessions. Furthermore, chances of robust performances are bleak in the absence of any solid catalyst, after the decent outperformance of the REIT – Other industry in the prior years.

Nonetheless, REITs have reduced their exposure to rate hikes and used the low-rate environment to make their financials more flexible, which is encouraging for operational efficiencies. And despite the overall industry’s gloomy outlook, REITs catering to certain asset categories have prospects to excel. Therefore, we present three stocks from the industry with a favorable Zacks Rank that investors may consider adding to their portfolios amid global uncertainties and slowdown as well as the U.S. presidential election.

San Francisco, CA-based Prologis, Inc. (PLD - Free Report) is a leading industrial REIT that acquires, develops, operates and manages industrial properties in the United States and across the globe. The company is poised to excel as the industrial real estate market is witnessing improving fundamentals amid e-commerce boom and supply-chain strategy transformations. This Zacks #2 (Buy) Ranked stock has been a decent performer, having beaten the Zacks Consensus Estimate in three of the trailing four quarters and meeting in the other, the average positive surprise being 1.75%. In the fourth quarter, the company registered net effective rent growth. Reflecting positive sentiments, the stock’s Zacks Consensus Estimate for the current-year FFO per share moved nearly 1.6% north to $3.72 over the past month.



 

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

SL Green Realty Corporation (SLG - Free Report) primarily engaged in the acquisition, development, ownership, management and operation of commercial real estate properties, mainly office properties, in the New York metropolitan area, especially in Manhattan. This Zacks Rank #2 company came up with positive surprises in terms of FFO per share in three of the preceding four quarters, the average beat being 1.15%. The company’s fourth-quarter results reflected strong leasing activity in the Manhattan portfolio. Also, the trend is estimate revisions indicates an upbeat outlook as the Zacks Consensus Estimate for ongoing-year FFO per share moved nearly 2% north over the past month.

Boston Properties BXP develops, manages, operates, acquires and owns a diverse portfolio of mainly Class A office space in the United States. The company’s properties are primarily concentrated in five markets — Boston, Los Angeles, New York, San Francisco and Washington, DC. It holds a Zacks Rank of 2, at present. This REIT is a decent performer having beaten the Zacks Consensus Estimate with respect to FFO per share in each of the last four quarters, the average beat being 2.06%. In the recently-reported quarter, greater-than-projected portfolio performance, backed by higher occupancy, buoyed results. Additionally, Boston Properties’ Zacks Consensus Estimate for the 2020 FFO per share increased marginally to $7.56 in a week’s time.

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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