For Immediate Release
Chicago, IL – September 20, 2017 – Today, Zacks Equity Research discusses the Industry: REITs, Part 2, including Getty Realty Corp. (NYSE: (GTY - Free Report) – Free Report), Preferred Apartment Communities, Inc. (NYSE: (APTS - Free Report) – Free Report), InfraREIT, Inc. (NYSE: (HIFR - Free Report) – Free Report) and TIER REIT, Inc. (NYSE: (TIER - Free Report) – Free Report).
Industry: REITs, Part 2
The REIT industry’s performance has long being ruled by movements in interest rates, particularly treasury yields. But with fundamentals of the underlying assets playing as important a role in determining REITs’ price performance, demand-supply dynamics and tenant performance are commanding attention.
In fact, a number of asset categories are displaying strength with the economy and the job market showing signs of recovery. The REITs catering to these are generating solid returns, at times even above the broader market.
Moreover, the growing importance of the REIT industry over the years is quite evident and the creation of the exclusive headline sector for real estate under the Global Industry Classification Standard (GICS) last year raised expectations of drawing in billions and pushing up valuations over time.
Also, the U.S. REIT market has continued to expand with the FTSE NAREIT All REITs Index, comprising 227 REITs with a combined equity market capitalization of $1.126 trillion at the end of August 2017. This is ahead of 219 REITs and $972 billion in equity market capitalization at the end of April 2016.
Further, investors' faith in this sector and their willingness to pour money into it is increasing. This is apparent when we look at the industry’s capacity to raise capital from the market. In fact, in the first eight months of 2017, REITs raised $62.8 billion of capital that was well ahead of the $52.3 billion generated in the comparable period prior year.
Therefore, the time is now apt to explore the industry in depth and scoop up big gains.
Data Center REITs
Growth in cloud computing, Internet of Things and big data, and an increasing number of companies opting for third-party IT infrastructure are driving demand for data center REITs. In fact, demand is outpacing supply in top-tier data center markets and despite enjoying high occupancy, these markets are absorbing new construction at a faster pace.
Additionally, according to a Cisco forecast, global “data center-to-data center” IP traffic is expected to witness a compound annual growth rate of 32% over the 2015-2020 period. Further, per Gartner reports, worldwide IT spending growth is projected to increase 3.3%, while worldwide server shipments are expected to rise 4.0% in 2017. This, along with improved outlook for economic growth, is anticipated to drive demand for data centers. In fact, this REIT segment pulled in capital and scored well on the return book through August 2017, registering total returns of 31.8%.
In the industrial real estate market, demand for space has been high for several quarters. Going by numbers, per a study by the commercial real estate services’ firm – CBRE Group Inc. (NYSE: CBG – Free Report) – the overall U.S. industrial real estate market remained upbeat in the second quarter, with the industrial availability rate declining 10 basis points to 7.8%.
This marked not only the market’s 27th decline in the past 28 quarters, but also the lowest level since first-quarter 2001. Obviously, a recovering economy and job market gains aided this improvement, but the e-commerce boom and a healthy manufacturing environment were the chief drivers. Also, lower-than-expected completion of construction kept supply numbers at check.
Particularly, amid economic expansion, e-commerce development and heightened urbanization, companies are shifting their strategy toward services like same-day delivery and other options, propelling demand for warehouse distribution facilities. Also, according to a report from Prologis Inc. (NYSE: PLD – Free Report), for a given level of revenues, online retailers require three times the distribution center space compared with traditional retailers. This is creating scope for industrial REITs like Prologis, DCT Industrial Trust Inc. (NYSE: DCT – Free Report) and Liberty Property Trust (NYSE: LPT – Free Report) to prosper.
In addition, the U.S. office vacancy rate remained steady at 13% in the second quarter amid balanced demand-supply, according to a report from CBRE Group. In around half of the U.S. office markets, vacancy recorded a decline and the national office vacancy rate is hovering close to its post-recession low.
Additionally, corporate profits are up and business confidence has recovered. Going forward, with economic improvement and recovery in the job market, demand for office space is expected to shoot up.
Zacks Industry Rank
Within the Zacks Industry classification, REITs are broadly grouped in the Finance sector (one of the 16 Zacks sectors) and 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 256 industries in 16 Zacks sectors based on earnings outlook and fundamental strength of the constituent companies in each industry.
We club 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.)
However, the industry ranking is not encouraging for the majority of the REIT industry. In fact, the Zacks Industry Rank is #190 (bottom 26% of the 250 plus Zacks industries) for Retail REIT, #178 (bottom 30%) for Residential REIT, #175 (bottom 32%) for Other REIT and #157 (bottom 39%) for Mortgage REIT.
Nevertheless, no discussion is complete until we weigh the performance of REITs in earnings and despite wide skepticism of investors toward this industry, it emerged as a decent performer in the recently concluded reporting cycle.
In fact, per a NAREIT media release, occupancy rates remained high in the second quarter, while funds from operations (FFO), a widely used metric to gauge the performance of REITs, reported growth.
Specifically, the second-quarter scorecard revealed that the total FFO of the listed U.S Equity REIT industry of $15.6 billion in the reported quarter increased 7.9% sequentially. The figure also came in 7.3% higher than the prior-year quarter tally.
Same-store net operating income (NOI) grew 3.3% year over year. Results were driven by segments like Single Family Homes, Data Centers and Manufactured Home Communities, which witnessed robust same-store NOI growth of 6.8%, 5.8% and 5.7%, respectively.
Furthermore, properties owned by the listed Equity REITs enjoyed solid occupancy levels. In fact, the occupancy rate remained unchanged at 93.4%, slightly below the record-high occupancy rate of 93.7% in the third and fourth quarters of 2016.
Further, the finance sector, of which REITs are part, is expected to grow in 2017. Total Q3 earnings for the S&P 500 index members from this sector are expected to be up +2.5% from the same period last year on +1.9% higher revenues.
For more information on earnings for this sector and others, please read Q3 Earnings Season Gets Underway.
REITs Worth Adding
In this mixed environment, sidelining the entire industry would not be prudent. Rather, there are chances of scooping up big gains from this special hybrid asset class which benefits from the favorable dynamics of the individual asset categories. So, investors need to remain cautiously optimistic, assess the fundamentals of the underlying asset category as well as the capacity of REITs to absorb a rate hike. Hence, things like lease durations and pricing power in the market would command attention.
Over the last six months, the industry has gained around 2.8% compared with the S&P 500’s return of 5.3%. As the industry underperformed the broader market, the stocks are good bargains now.
Investors can consider the following REIT stocks that have solid fundamentals to weather any rate hike. Also, their favorable Zacks Rank makes them solid picks.
Jericho, NY-based Getty Realty Corp. (NYSE: GTY – Free Report) is a REIT engaged in the ownership, leasing and financing of convenience store and gasoline station properties in the United States. The stock has a Zacks Rank #1 (Strong Buy). Getty Realty has exceeded estimates in three out of the trailing four quarters with an average beat of 9.8%. The stock has seen the Zacks Consensus Estimate for current-year revised 3.1% upward in a month’s time.
Preferred Apartment Communities, Inc.(NYSE: APTS – Free Report), based in Atlanta, GA, acquires and operates multifamily properties primarily in the United States. The stock has a Zacks Rank #2 (Buy) and a VGM Score of A. Preferred Apartment Communities has been a steady performer, having beaten the Zacks Consensus Estimate in three out of trailing four quarters, with an average beat of 6.9%. Its long-term expected growth rate is currently pegged at 7%, ahead of the industry average of 6.3%. You can see the complete list of today’s Zacks #1 Rank stocks here.
InfraREIT, Inc.(NYSE: HIFR – Free Report), based in Dallas, TX, enjoys ownership of transmission & distribution properties with long lives, low operating risks and stable cash flows. It has Zacks Rank #2 and its expected long-term growth rate currently stands at 8%.
TIER REIT, Inc. (NYSE: TIER – Free Report) is a Dallas, TX-based REIT that focuses on ownership of premium, well-managed commercial office properties in dynamic markets throughout the United States. For the past few quarters, TIER REIT has been displaying strength, exceeding the Zacks Consensus Estimate in each of the trailing four quarters, with an average beat of 9.6%. Also, the stock has seen the Zacks Consensus Estimate for current-year being revised 2.6% upward in two months’ time.
Note: All EPS numbers presented in this write up represent funds from operations (FFO) per share. FFO, a widely used metric to gauge the performance of REITs, is obtained after adding depreciation and amortization and other non-cash expenses to net income.
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