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Why It's Plain Stupid to Buy These 4 High-Yield REITs Now

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The real estate investment trust (REIT) sector seems to be having a tough time due to the rising rate environment. In addition, new supply in certain asset categories and the rising trend of online purchases make the growth prospects bleak for the entire segment.

Consecutive hike in the interest rates over the past three quarters has taken a toll on the profitability of REITs. This is because REITs are typically dependent on debt for business, mainly borrowing at short-term lending rates and investing at long-term yield. However, the U.S. economy has been witnessing a steepening of short-term interest rate curve, while long-term yields remain low.  

Admittedly, concerns over another rate hike in December and movement of long-term treasury yields have made investors skeptical about investing in REIT stocks that are often considered as bond substitutes due to their high and consistent dividend-paying nature.

Moreover, the increasing number of retailers jumping on the dot-com bandwagon has created pressure on the top-line figure for retail REITs. Many retailers are filing for bankruptcy and opting for store closures, as mall traffic has been shrinking due to the soaring online purchases. Although these REITs are actively enhancing the omni-channel capabilities and heavily investing in redevelopment to lure customers, it may take a while for these efforts to offset the dent created in the operating results.

Elevated supply levels of new properties in several key markets have also plagued the fundamentals for many REITs operating in the residential, storage and healthcare segments. Oversupply, along with subpar demand, curtails the landlords’ pricing power and also dampens rent growth.

Moreover, it affects the absorption and occupancy levels of the properties. With a number of new projects scheduled to be delivered in the upcoming quarters, there seems to be no relief from the present scenario.

Performance of Different REIT Segments versus S&P 500

Although REITs provide high dividends, majority of the companies have lagged behind the broader market, year to date. Three of the four Zacks industries — Retail REIT, Residential REIT and Other REIT have underperformed the S&P 500 Index.

The Residential and Other industry have gained 5.3% and 5.4%, respectively, versus the S&P 500’s rally of 10.8%. Meanwhile, the Retail segment has lost 6.8%. However, Zacks Mortgage REIT industry has outperformed the index with 11.2% growth.

Zacks Industry Rank Indicates Gloomy Prospects  

The Zacks Industry Rank is #190 (bottom 26% of the 250 plus Zacks industries) for Retail REIT, #198 (bottom 23%) for Residential REIT, #160 (bottom 38%) for Mortgage REIT and #169 (bottom 34%) for Other REIT. Our back-testing shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

5 Stocks to Avoid

Washington Prime Group Inc. (WPG - Free Report) is a retail REIT and currently carries a Zacks Rank #4 (Sell). Shares of the company have lost 19.8% year to date, underperforming the 6.5% decline recorded by its industry. Also, the Zacks Consensus Estimate for funds from operation (FFO) for third-quarter 2017 has been revised 4.8% downward to 40 cents in a month’s time.

Whitestone REIT (WSR - Free Report) is a fully-integrated real estate investment trust that acquires, owns, manages, develops and redevelops high quality internet-resistant neighborhood, community and lifestyle retail centers. It carries a Zacks Rank #4. Shares of the company have lost 12.8% year to date, underperforming 6.2% growth recorded by its industry. Further, in a month’s time, the Zacks Consensus Estimate for third-quarter 2017 FFO has been revised downward 3% to 33 cents.

Select Income REIT (SIR - Free Report) is a residential REIT carrying a Zacks Rank #4. Shares of the company have lost 7.9% year to date, underperforming 5.4% growth recorded by its industry. In addition, the Zacks Consensus Estimate for third-quarter FFO edged down 1.4% to 69 cents during the same time frame.

Ares Commercial Real Estate Corp. (ACRE - Free Report) is a specialty finance company focused on originating, investing in and managing middle-market commercial real estate loans, and other commercial real estate investments. It carries a Zacks Rank #4. Shares of the company have lost 3.9% year to date, underperforming 11.2% growth recorded by its industry. Moreover, the Zacks Consensus Estimate for FFO third-quarter 2017 has been revised downward 3.6% to 27 cents in a month’s time.

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

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