Will the REIT Industry be Able to Sustain Momentum in 2015?

Real estate investment trust (REIT) investors have lately been a little jumpy with an improving economy, a solid job report and an enhanced level of economic activity on the one hand and the associated anticipations of the Federal Reserve’s tightening cycle on the other. While positive data strengthens the industry’s fundamentals and builds demand for commercial properties, a rate hike would wipe out all the optimism.

In fact, the latest job report, which signals a revival of the domestic economy, sent REIT stocks into the red with treasury yields shooting up amid speculations of a rise in interest rates in the first half of 2015.

Essentially, rising rates imply higher borrowing cost for the REITs that would affect their ability to purchase or develop real estate. Moreover, REIT stock yields become less attractive when treasury yields rise.

REITs: Playing the Volatility

Then again, the REIT industry emerged a winner from the widespread volatility that ruled for most of last year and is expected this year too. It also saw a strong start to this year and outperformed the broader equity market in January thanks to the low treasury yields and interest rates plus improving fundamentals.

The total return of the FTSE NAREIT All REITs Index was 5.6% for January, against a 3.0% decline for the S&P 500. This strength follows an exceptionally good 2014 that witnessed the FTSE NAREIT All REITs Index gaining 27.2% compared with a return of 13.7% for the S&P 500.

Dividends Standing Tall

Global uncertainties, both in the money and commodities markets, helped dividend-paying stocks gain traction. Therefore, along with the capital appreciation, yield-hungry investors still have a large appetite for REIT stocks as the U.S. law requires REITs to distribute 90% of their annual taxable income in the form of dividends.

In fact, as of Dec 31, the dividend yield of the FTSE NAREIT All REITs Index was 4.00%. The yield of the FTSE NAREIT All Equity REITs Index was 3.56% while the FTSE NAREIT Mortgage REITs Index yielded 10.66%. Clearly, the REITs continued to offer solid yields and outpaced the 2.04% dividend yield offered by the S&P 500 as of that date.

Can REITs Tap an Improving U.S. Economy?

That the U.S. economy is improving has already been acknowledged by the Fed in its latest FOMC meeting. IMF and the World Bank have concluded the same thing. And after scanning the recent economic data releases -- ranging from labor market, consumer confidence, manufacturing, retail, consumer spending and consumer credit -- we are only reassured about this recovery.
 
Economic recovery leads to stepped-up economic activity that could increase the demand for space from retailers, manufacturers, distributors, offices and renters. This is because a greater workforce needs more space for accommodation, and enhanced purchasing power leads to higher demand for retail goods. This also translates into increased industrial activity while their distribution needs logistic facilities, thereby increasing the demand for real estate. A fatter wallet also means better rent-paying ability that drives the demand for apartments.

Therefore, going forward, if investors can manage the short-term hiccups, the fundamental strengthening can ensure solid long-term gains. Also, these hiccups can offer you solid entry points.  

However, as the worth of any REIT stock depends much on the asset type in which it invests as well as on the local economy, a careful approach needs to be taken in selecting the stocks for your portfolio.

In this environment, one could bet on top-ranked stocks like Regency Centers Corp. (REG - Analyst Report), American Assets Trust, Inc. (AAT), Pennsylvania Real Estate Investment Trust (PEI - Snapshot Report), Whitestone REIT (WSR - Snapshot Report), Ashford Hospitality Trust, Inc. (AHT - Snapshot Report), Prologis, Inc. (PLD - Analyst Report), Public Storage (PSA - Analyst Report), Host Hotels & Resorts, Inc. (HST - Analyst Report), SL Green Realty Corp. (SLG - Analyst Report), Silver Bay Realty Trust Corp. (SBY - Snapshot Report), Equity Residential (EQR - Analyst Report), CYS Investments, Inc. (CYS - Snapshot Report) and American Capital Agency Corp. (AGNC - Analyst Report).

Capital Access

REITs have also been very active in the capital market in 2014. They have opportunistically leveraged the low rate environment for refinancing their debts, which is encouraging. Also, this indicates the rise in investors’ confidence in this sector and their willingness to pour money into it.

As of Dec 31, 2014, REITs raised $63.64 billion in initial, debt and equity capital offerings (IPOs - $3.98 billion, Secondary Common - $24.1 billion, Secondary Preferred - $4.6 billion and Secondary Debt - $30.9 billion).

Zacks Industry Rank

In the Zacks Industry classification, REITs are broadly grouped into the Finance sector (one of 16 Zacks sectors) and further sub-divided into four industries at the expanded level: REIT Equity Trust - Retail, REIT Equity Trust - Residential, REIT Equity Trust - Other and REIT Mortgage Trust.

Based on the earnings outlook for the constituent companies in each industry, we rank all of the 250+ industries in the 16 Zacks sectors. This ranking is available on the Zacks Industry Rank page.

As a point of reference, the outlook for industries with Zacks Industry Rank #88 and lower (the top one-third of the list) is 'Positive,' between #89 and #176 is 'Neutral,' and #177 and higher (the bottom one-third) is 'Negative.'

The Zacks Industry Rank for REIT Equity Trust - Other is #45, REIT Mortgage Trust is #71, REIT Equity Trust - Retail is #98, and REIT Equity Trust - Residential is #100. Looking at the Zacks Industry Rank for different REIT segments, it is obvious that the outlook for REIT industry as a whole is in the positive-to-neutral zone.

Earnings Trends

The broader Finance sector, of which the REITs are part, witnessed a 2.5% decline in earnings on 1.9% lower revenues, with 71.9% beating EPS estimates and 52.9% coming ahead of revenue expectations, mainly due to the weak performance by Banks – Major as well as Banks and Thrifts. Though a major chunk of the REIT companies have yet to report, we find Real Estate earnings have grown 72.1% on 21.3% higher revenues.

However, introspection into the overall results or individual sectors clearly depicts weakness on the revenue side. Importantly, estimates for the current and following quarters have been coming down sharply.

Nevertheless, total earnings are projected to be up 9.2% year over year in the first quarter 2015 and 2.7% in the second quarter. However, things are expected to improve for the overall Finance sector from the third quarter with expectations for earnings growth of 10.4% for third quarter, 13.3% for fourth quarter and 12.3% for full-year 2015.

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

SUMMARY

Real estate investment trust (REIT) investors have lately been a little jumpy with an improving economy, a solid job report and an enhanced level of economic activity on the one hand and the associated anticipations of the Federal Reserve’s tightening cycle on the other. While positive data strengthens the industry’s fundamentals and builds demand for commercial properties, a rate hike would wipe out all the optimism.