REITs dependence on debt for their business and consideration as bond substitutes for their high and consistent dividend-paying nature make investors skeptical about their performance in a rising rate environment.
But barring short-term hiccups, this special hybrid asset class has proven time and again that rate hikes do not necessarily impact long-term returns from REIT stocks. Rather, in most cases, REITs have rallied and outperformed the broader market, when rates increased.
In fact, per a study from S&P Global, there have been six periods during which the 10-Year U.S. Treasury Bond yields increased substantially since the early 1970s. In half of those six periods, U.S. REITs outperformed the S&P 500, matched in another and missed in the remaining two. Further, U.S. REITs generated positive returns in four of those six periods. This implies that REITs actually gather more steam amid rising rates.
Of course, a rise in interest rate affects the present value of future cash flows. Therefore, asset valuation, including bond coupons and stock dividends, experiences a decline. But, for REITs, a rise in rates also ushers in scope for increasing future cash flows and this is how REITs emerge as winners even with rate hikes.
In fact, any decision by the Fed to increase rate mirrors growth in the domestic economy, rising inflation and the Fed’s confidence in the recovery. And when the economy expands, there is growth in jobs and consumer spending. This in turn drives the prospects of the real estate sector because growth in the economy translates into greater demand for real estate, higher occupancy levels and landlord’s greater power to ask for higher rents.
And why not? Everything is not possible virtually and one will eventually need “real space” for economic activities. Therefore, a REIT’s earnings, cash flow and dividend get a boost as rate increases amid economic growth.
Moreover, REITs have been proactive in the capital market in recent years. They have opportunistically used the low-rate environment to make their financials more flexible, which is encouraging down the line for their operational efficiencies.
Further, investors' faith in this sector and their willingness to pour money into it is increasing. The stock exchange-listed REITs collected $69.6 billion in capital offerings in 2016 and raised $62.8 billion of capital in the first eight months of 2017 — well ahead of the $52.3 billion generated in the comparable prior-year period.
In addition, the growing importance of the REIT industry over the years is quite evident with the creation of the exclusive headline sector for real estate under the GICS last year. Indeed, the REIT market has continued to expand with the FTSE NAREIT All REITs Index, comprising 227 REITs, had 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.
As such, rather than pondering too much on rate hike and treasury yield moves, it would be prudent for investors to delve more into the fundamentals of the underlying sector to which REITs cater to and the impetus the asset category will receive from a growing economy.
4 Stocks to Scoop Big Gains
Here we handpicked four REIT stocks that sport a favorable Zacks Rank. These stocks have been witnessing positive estimate revisions. Also, their underlying asset categories display strength with the economy and the job market showing signs of recovery. Moreover, don’t ignore the hiccups in rate hikes, because those can provide solid entry points too.
Los Angeles, CA-based Rexford Industrial Realty, Inc. REXR is focused on acquisition, ownership and operation of industrial properties situated in Southern California infill markets. Rexford has a Zacks Rank #2 (Buy). It has a long-term growth rate of 6.8%.
This Industrial REIT is set to prosper given that a recovering economy and job market gains are aiding the growth of this industry. Specifically, e-commerce boom and a healthy manufacturing environment have emerged as the chief drivers. In a year, even with three rate hikes, the stock has gained 38.1% in a year’s time and significantly outperformed the industry’s 1.7% growth.
Glendale, CA-based PS Business Parks Inc. PSB is into ownership, acquisition, development and operation of commercial real estate properties, especially multi-tenant flex, office, and industrial assets. The healthy fundamentals in these asset categories in an improving economy and solid job gains are anticipated to drive growth while portfolio repositioning strategies are likely to help the company emerge stronger. PS Business Parks has a Zacks Rank #2.
For the past few quarters, PS Business Parks has been displaying strength, exceeding the Zacks Consensus Estimate in each of the trailing four quarters, with an average beat of 3.16%. Also, return on equity (ROE) is 16.5% compared with the industry average of 6%. This indicates that the company reinvests more efficiently than the industry. Over the past year, the stock has gained 24.7%, outperforming the industry’s ascend of 1.7%.
InfraREIT, Inc. HIFR, based in Dallas, TX, enjoys ownership of transmission & distribution properties with long lives, low operating risks and stable cash flows. It has a Zacks Rank #2 and its expected long-term growth rate currently stands at 8%.
The stock has seen the Zacks Consensus Estimate for current-year earnings being revised 10.2% upward in two months’ time. And why not, the fundamentals of this industry remain solid with a strong growth profile and robust pipeline. In fact, infrastructure REITs have gained 34.1% this year through August. Also, shares of InfraREIT gained 18.3% over the past year, outperforming the industry’s ascend of 1.7%.
Preferred Apartment Communities, Inc. APTS acquires and operates multifamily properties primarily in the United States. The stock has a Zacks Rank #2 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 6.4%. The stock has gained 30.6%, significantly outperforming the Residential REIT industry’s 6.4% rally.
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