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Encouraging Near-Term Outlook for Equity REIT Stocks

Moumita Chattopadhyay

The Zacks REIT and Equity Trust - Other industry is a diversified group, covering REIT stocks from different asset classes like industrial, office, lodging, healthcare, self-storage, data centers and others. The REITs rent space in these properties to tenants and earn a rental income in return.

Some of the prominent players in this industry are infrastructure REITs like American Tower Corp. (AMT), Crown Castle International (CCI) and SBA Communications Corp. (SBAC), industrial REIT Duke Realty Corporation (DRE), healthcare REITs like HCP Inc. (HCP), Ventas, Inc. (VTR), and Welltower, Inc. (WELL), office REITs like Boston Properties (BXP), and SL Green Realty Corp. (SLG), data center REITs like Digital Realty Trust (DLR) and Equinix, Inc. (EQIX), self-storage REIT Public Storage (PSA), lodging REIT Host Hotels & Resorts (HST), diversified REIT Vornado Realty Trust (VNO) and specialty REIT Iron Mountain (IRM).

Let’s take a look at the industry’s three major themes:

  • The industry is poised to benefit from technological evolution, which has been changing the dynamics of the real estate market and substantially driving demand at a number of asset categories. Particularly, the e-commerce boom is fueling demand for logistics facilities, besides helping cell towers and data centers. Companies are making immense efforts to improve supply-chain efficiencies, propelling demand for logistics infrastructure and efficient distribution networks. Additionally, with growth in cloud computing, artificial intelligence, Internet of Things and big data, and an increasing number of companies opting for third-party IT infrastructure, data-center REITs are experiencing a booming market. Also, in deploying of 5G network, tower REITs have become crucial. Moreover, data-analytics expertise of self-storage REITs is offering a competitive advantage and driving their performance. Further, increasing longevity of the aging U.S. population, along with biopharma drug development growth opportunities, have also promoted the institutional life science and medical-market fundamentals.
     
  • The strength in the economy and job market plays a key role in determining REITs’ performance. Both these factors determine the capacity of rent that can be shelled out. Although economic growth is likely to be less robust this year, the level will likely remain stable, supporting the industry. Moreover, easy availability of capital and comparatively lower levels of interest rates keep the momentum upbeat for REITs given their substantial dependence on debt and since these are considered as a bond substitute for their high dividend-paying nature. Along with that, growth in the millennial generation is redefining retail trends and leading to an e-retail boom, thereby opening up scope for Industrial REITs’ growth. Boomers have also been embracing technology, adding to such favorable trends. Also, the aged population or the “silver tsunami” is shaping up the future of healthcare REITs, since this group constitutes the largest customer base of healthcare services, spending more on such services than the average population, spurring demand for seniors housing assets, skilled nursing facilities and others.
     
  • However, rising delivery of new units in a number of asset categories, such as industrial, office, senior housing and self-storage, has kept REITs on tenterhooks. There has been a steady rise in construction activities and with increased completions, landlords’ ability to command more rents and increase occupancy levels is moderating, leading to high concessions. Particularly, the healthcare REITs continue to witness softness in seniors’ housing fundamentals as supply has of late shot up rapidly in this asset category. The development boom in many markets is also tempering the growth pace in the self-storage industry. Moreover, with excess labor inflation amid tight labor market, margins are likely to be under pressure. Further, any protectionist trade policies will not only have an adverse impact on economic growth, but also affect the business of industrial REITs over the long run.


Zacks Industry Rank Indicates Bright Prospects

The Zacks REIT and Equity Trust - Other industry is housed within the broader Zacks Finance sector. It carries a Zacks Industry Rank #95, which places it at the top 37% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates solid near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

The industry’s positioning in the top 50% of the Zacks-ranked industries is a result of positive funds from operations (FFO) per share outlook for the constituent companies in aggregate.

Before we present a few stocks that you may want to consider for your portfolio, let’s take a look at the industry’s recent stock-market performance and valuation picture.

Industry Leads on Stock Market Performance

The REIT and Equity Trust - Other Industry has outperformed the broader Zacks Finance sector, as well as the Zacks S&P 500 composite in a year’s time.

The industry has rallied 19.7% during this period compared to the S&P 500’s rise of 1.8%. During the same time frame, the broader Finance sector has declined 1%.

One-Year Price Performance



Industry’s Current Valuation

On the basis of forward 12-month price-to-FFO (funds from operations) ratio, which is a commonly used multiple for valuing REIT - Others, we see that the industry is currently trading at 18.14X compared to the S&P 500’s forward 12-month price-to-earnings (P/E) of 17.07X. The industry is trading above the Finance sector’s forward 12-month P/E of 13.96X. This is shown in the chart below.

Forward 12 Month Price-to-FFO (P/FFO) Ratio



Over the last five years, the industry has traded as high as 18.94X, as low as 14.24X, with a median of 16.08X.

Bottom Line

In a nutshell, the REIT – Other industry is poised for growth amid stable economy and job-market gains, favorable demographics, technological developments and lifestyle transformations. Nonetheless, the delivery boom in certain asset classes in the near- to mid-term may strain rental rates and result in high concessions.

In addition to the above, REITs have improved their leverage level over the years. This looks encouraging for their operational efficiencies, as well as for investors, since interest expense may take a smaller bite out of REITs’ earnings. Consequently, dividend yields and profitability for investors are predicted to improve.

Here we present three stocks from the industry with a favorable Zacks Rank that investors may consider adding to their portfolio.

San Francisco, CA-based Prologis, Inc. (PLD) is a leading industrial REIT that acquires, develops, operates and manages industrial properties in the United States and across the globe. The company is poised to excel as the industrial real estate market is witnessing improving fundamentals amid growth of e-commerce business and supply-chain strategy transformations. This Zacks #2 (Buy) Ranked stock has been a steady performer, having beaten the Zacks Consensus Estimate in each of the trailing four quarters, with an average positive surprise of 1.35%. Reflecting positive sentiments, the stock’s Zacks Consensus Estimate for the current-year FFO per share moved 1.5% north to $3.28 over the past three months.



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

Alexandria Real Estate Equities, Inc. (ARE) owns, operates and develops collaborative technology and life-science campuses mostly in the coastal regions of the United States. The firm focuses on what it calls “innovation clusters,” which includes New York City, Greater Boston, Seattle, San Francisco, and a few other areas. The Zacks #2 Ranked stock’s FFO per share growth rate for the ongoing year is projected at 5.76%.



Salt Lake City, UT-based Extra Space Storage Inc.’s (EXR) high brand value, strategic acquisitions and robust presence in key cities serve as growth drivers amid healthy demand in the self-storage industry. It has a Zacks Rank of 2, at present. Also, Extra Space Storage’s Zacks Consensus Estimate for the ongoing year’s FFO per share increased 1.04% to $4.87 in two months’ time.




Note: Funds from operations (FFO) is a widely used metric to gauge the performance of REITs rather than net income as it indicates cash flow from their operations. FFO is obtained after adding depreciation and amortization to earnings and subtracting the gains on sales.


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