The year 2014 opened up like a Chinese box for the U.S. real estate investment trusts (REITs), each revealing a new surprise. Thanks to the treasury yields and interest rates movement, the REIT industry had a profitable 2014.  

In fact, the U.S. REIT stocks made a solid turnaround this year, following the underperformance to the broader equity market in 2013. As of Dec 24, the FTSE NAREIT All REITs Index ascended 28.2% compared to the S&P 500’s (SPX) 14.9% gain. This compares to last year’s FTSE NAREIT All REITs Index’s gain of just 3.2% as against the S&P 500’s decent 32.4% run up.

Economy Played the Key Role

REITs are often treated as bonds because of their high dividend paying nature and therefore, treasury yields end up playing a significant role in their price movement.

The year 2014 witnessed some unusual movements in yields. At the start of the year, treasury yields hovered around 3% and there were expectations of it reaching 3.5% by the year end. But defying all predictions, the treasury yields tanked before recovering slightly in recent times on the +5% GDP report. And market analysts again expect it to be within 3% by year-end 2015, signaling a relief for the REIT industry.

Moreover, even though the Federal Reserve wrapped up its bond buying program this year, the agency adopted a dovish attitude on hiking interest rates.

The Fed commented that it would keep its key lending rate near zero for a “considerable time” before replacing it with the phrase “the committee judges it can be patient” in its latest December meeting. Further, with the Fed Chair disclosing that the committee is not anticipating rate hikes in at least a couple of next meetings too, the REIT investors heaved a sigh of relief and continued to build their hopes.

Investors also looked beyond these factors and appreciated the fundamentals of the industry. They recognized that global issues could not interrupt economic recovery in the U.S.

An enhanced consumer confidence and cheap oil prices boosted purchasing power of consumers, driving up economic activity and steadily leading to elevated demand for real estates.

But with the sluggish pace of economic recovery over the past quarters, supply of new construction remained modest, giving the present real estate owners a solid scope to capitalize on. Financially too, the REITs beefed up their strength by leveraging on the low rate environment for refinancing their debts, which is encouraging.  
 

3 Market Beating REITs

Here we present three stocks that returned better than the S&P 500 in 2014 and are poised to gain from the upbeat economic trends, aside from having a good Zacks rank and decent long-term growth rate.

Chatham Lodging Trust (CLDT -Snapshot Report), based in Palm Beach, FL, invests in upscale extended-stay hotels and premium-branded, select-service hotels. It owns stake in 130 hotels aggregating 17,858 rooms/suites – 34 hotels wholly owned with 5,115 rooms/suites in 15 states and the District of Columbia and 96 hotels with a total of 12,743 rooms/suites owned in joint ventures.

Chatham Lodging Trust has a Zacks Rank #2 (Buy) and an expected long-term growth rate of 22.7%. The stock has gained 44.8% year-to-date.

RLJ Lodging Trust (RLJ - Snapshot Report), domiciled in Bethesda, MD, focuses on the acquisition of premium-branded, focused-service, and compact full-service hotels. Under its ownership, the company has 150 properties in 21 states and the District of Columbia. This includes 148 hotels with around 23,300 rooms and two planned hotel conversions.

Apart from a Zacks Rank #2, the company has long-term expected earnings growth of 10.1%. The stock has gained 40.6% year to date.

AvalonBay Communities Inc. (AVB - Analyst Report) primarily focuses on developing multifamily apartment communities in high barrier-to-entry regions of the U.S. These markets include the Northeast, Mid-Atlantic, Pacific Northwest, and the Northern and Southern California regions of the U.S. The company is based out of Arlington, VA, and owned or held a direct or indirect ownership stake in 274 apartment communities (82,333 apartment homes) as of Sep 30, 2014.

AvalonBay holds a Zacks Rank #3 (Hold) and has a long-term expected growth of 10.8%. The stock has gained 41.6% year to date.

Bottom Line

We note that the varying predictions for the timing of interest rate hike and treasury yields resulted in hiccups this year but could not eat away all the gains. This testifies to the fact that rates have a short-term impact while fundamentals have a long-term consequence.  

In fact, rates will eventually have to move north in tune with the U.S. economic recovery. But as long as the rate hikes are triggered by a stronger economy, we believe that the increased financing cost as a result of higher interest rates will be offset by the associated economic opportunity, giving investors a solid chance to grab good returns, apart from enjoying a solid dividend income.