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REIT Industry Stock Outlook - October 2016

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The real estate investment trust (REIT) industry managed to outpace the broader market in the first nine months of the year. This outperformance primarily suggests a growing appetite of investors for REIT stocks amid lingering rate issues.

In fact, despite the hiccups that resulted from rate hike speculation in the recent month and supply growth issues in some of the asset categories, for the year through Sep 30, the FTSE/NAREIT All REIT Index managed to record a total return of 12.6% compared with the 7.8% increase logged by the S&P 500 Index. On the other hand, the yield on the 10-year Treasury note declined 0.7% over this time frame.

Further, a number of events have occurred in recent times and these events are expected to substantially shape the REIT industry’s outlook. The most notable among these is the promotion of Equity REITs, together with other real estate companies, to its own headline sector under the Global Industry Classification Standard (GICS), following the close of trading on Sep 16.

The move not only reflects the importance that real estate is gaining in the global economy, but is also expected to draw in billions into REITs as investment managers realign their portfolio strategies to bet more on this sector. So valuations are expected to get a push.

Second, the Federal Reserve decided to keep the rates unchanged in its September policy meeting. Obviously, the move relieved REIT investors for the time being because this debt-dependent industry will continue to benefit from the low-rate environment which keeps their borrowing costs down. On top of this, their dividend payout (which primarily makes them attractive) ends up being more lucrative than yields on fixed income and money market accounts in such an environment.

However, the outcome of the two-day meeting came with a grain of salt. The statement revealed Fed’s growing confidence in domestic economic growth. Yet, the central bank refrained from a rate hike call this time as it is waiting for “further evidence of continued progress toward its objectives.” Now, since a hike is almost ruled out in the next Fed meeting which is slated in an uncertain period right before the presidential election, a liftoff in December seems to be pretty much on the table.

Nevertheless, the supplementary summary of economic projections this time revealed a pull down in expectations of rate increases in the years ahead. So, even when rates rise, the pace is likely to be modest. REITs are expected to have time to adjust their business accordingly.

In addition to the above issues, the performance of REITs is largely determined by the demand-supply dynamics in individual asset categories. Therefore, as long as rate hikes are backed by an improving economy, REIT investors need not worry much. This is because when economic activity gathers steam, demand for space automatically grows.

Dividends Still Standing Tall

Moreover, dividends are by far the biggest enticement to invest in REIT stocks, especially for income-seeking investors. And encouragingly, as of Aug 31, the dividend yield of the FTSE NAREIT All REITs Index was 3.87%, which handily outpaced the 2.13% dividend yield offered by the S&P 500 as of that date. Over long periods too, REITs have outperformed the broader indexes with respect to dividend yields.

Notably, the U.S. law requires REITs to distribute 90% of their annual taxable income in the form of dividends to shareholders. This unique feature made the industry stand out and gain a solid footing over the past 15–20 years.

Capital Access

Further, in recent years, REITs have been proactive in the capital market. They have drawn leverage from the low rate environment and improved their financials. In 2015, a total of $59.3 billion in public capital was raised by stock exchange-listed REITs and in 2016 through Aug 31, REITs collected $52.3 billion in capital offerings.

Moreover, reforms to the Foreign Investment in Real Property Tax Act (FIRPTA) are expected to offer easy access to capital from foreign investors for publicly traded REITs and commercial real estate.

Zacks Industry Rank

Within the Zacks Industry classification, REITs are broadly grouped in the Finance sector (one of the 16 Zacks sectors) and are further sub-divided into four industries at the expanded (aka "X") level: REIT Equity Trust - Retail, REIT Equity Trust - Residential, REIT Equity Trust - Other and REIT Mortgage Trust. The level of sensitivity and exposure to different stages of the economic cycle vary for each industry.

We rank 265 industries in the 16 Zacks sectors based on the earnings outlook and fundamental strength of the constituent companies in each industry.

We put our industries into two groups: the top half (industries with the best average Zacks Rank) and the bottom half (the industries with the worst average Zacks Rank). Over the last 10 years, using a one-week rebalance, the top half beat the bottom half by a factor of more than 2 to 1. (To learn more visit: About Zacks Industry Rank.)

The Zacks Industry Rank is #72 for REIT Mortgage Trust, #77 for REIT Equity Trust - Retail, #80 for REIT Equity Trust - Residential, and #101 for REIT Equity Trust - Other.

Earnings Trends

With the impending Q3 earnings season, it’s time to look at the estimate revision trends. The broader Finance Sector, of which REITs are part, is currently expected to be up 3.7% from the same period last year on 1.3% higher revenues. This compares favorably to 2016 Q2 earnings reduction of 5.2% despite 1.8% higher revenues. Notably, for the S&P 500 constituents, the extent of negative revisions that Q3 estimates experienced has been lesser than the last few quarters. (Read: Is Earnings Recession Coming to an End?)

For more information about earnings for this sector and others, please read our ‘Earnings Trends’ report.

REITs Worth Adding

Investors can consider the following REIT stocks that have solid fundamentals to weather any rate hike. Also, their favorable Zacks Rank and decent dividend yield makes them solid picks.

CorEnergy Infrastructure Trust, Inc. (CORR - Free Report) is a U.S.-based REIT that seeks to invest primarily in the domestic energy infrastructure sector. With positive estimate revisions over the past two months, a dividend yield of 10.49% and the stock trading at a significant discount to the industry average, CorEnergy Infrastructure can be a solid addition to one’s portfolio. The stock currently has a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

InfraREIT, Inc. (HIFR - Free Report) owns rate regulated electricity delivery infrastructure assets primarily in Texas. This Zacks Rank #1 company has a long-term expected growth rate of 10% against the industry average of 5.8%. It has a dividend yield of 5.68% and experienced positive estimate revisions over the past three months.

Care Capital Properties, Inc. CCP, based in Chicago, is a REIT engaged in the ownership, acquisition and leasing of skilled nursing facilities and healthcare assets. It has a Zacks Rank #2 (Buy) and a dividend yield of 8.28%. With positive estimate revisions for the current year and the stock trading at a significant discount to the industry average, Care Capital Properties remains a preferred pick.

Washington Prime Group Inc. (WPG - Free Report) is a retail REIT based in Columbus, OH. It has a dividend yield of 8.41% and a Zacks Rank #2. It is a solid buy pick with positive estimate revisions for the current year and the stock trading at a substantial discount to the industry average.

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