The Zacks REIT and Equity Trust – Other industry is a diversified group, comprising REIT stocks from different asset categories such as industrial, office, lodging, healthcare, self-storage, data centers and others. The companies rent space in these properties to tenants and earn a rental income in return.
Traditionally, REITs have been dependent on debt for conducting business. Moreover, these companies are often considered as bond substitutes by the investment world, given their high and consistent dividend-paying nature. These create short-term hiccups for REITs, owing to rate hikes and movement of treasury yields, and with the Fed raising rates for the fourth time in 2018, there was no exception this time too.
However, 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. In fact, apart from rate issues, individual market dynamics of the underlying asset category play a crucial role in determining the performance of REITs.
Therefore, on one hand, an improving economy, job-market gains, corporate profits and tax cuts are spurring demand for several asset categories, driving occupancy levels and fueling the scope of generating future cash flows from the properties. And on the other hand, rising supply and evolving trade policies are softening fundamentals of related REITs.
Here are the major themes in the industry:
Technological Wave: Technological evolution has been changing the dynamics of the real estate market and substantially driving demand at a number of asset categories. For example, the e-commerce boom, which has largely affected retailers’ business model and kept retail REITs on tenterhooks, has on the other hand, significantly spurred demand for a separate set of REITs like cell towers, data centers and logistics facilities.
In addition, an increasing number of people consuming digital content and a solid estimated growth rate for the artificial intelligence, Internet of Things, autonomous vehicle and virtual/augmented reality markets, for the next five to eight years, raise hopes for remarkable growth in demand for space at cell-tower and data-center REITs. Also, data-analytics expertise of self-storage REITs are offering a competitive advantage and driving their performance. Focus on app-based, on-demand platform and increased adoption of automation to drive operational efficiencies will likely be the major factors in determining this sector’s performance.
Favorable Demographic Growth: Favorable demographic growth in age cohorts like millennials and baby boomers has been guiding the performance of a number of asset categories. Particularly, growth in the millennial generation is redefining retail trends and leading to an e-retail boom. With e-retailers optimizing distribution, demand for industrial warehouses are on the rise. Additionally, millennials’ preference to access apps for all kinds of services has prompted a number of REIT industries to adopt new technologies. Boomers have also been embracing technology, adding to such favorable trends.
Furthermore, the aged population or the “silver tsunami” is shaping up the fate of the healthcare REITs, since this group constitutes the largest customer base of healthcare services, which spends more on healthcare services than the average population, driving demand for seniors housing assets, skilled nursing facilities and others. Increasing longevity of the aging U.S. population, along with biopharma drug development growth opportunities, also has promoted institutional life-science and medical-market fundamentals.
Similarly, self-storage REITs too have been gaining from the increasing use of such facilities by the rising baby boomers and their preference for residential downsizing. These REITs are also benefiting from adoption of technology and serving the millennial generation.
Improving U.S. economy: The healthy U.S. economy and job-market gains are essential catalysts for this industry’s growth. Corporate profits are up, and corporate tax cuts are encouraging companies to deploy capital and increase wages. Also, consumer confidence is increasing, fueled by job growth and rising wages. These are translating into elevated demand for real estate, higher occupancy levels and landlords’ greater power to ask for higher rents.
Particularly, healthy growth in demand for office spaces might continue, as with economic revival, business grows, corporate sectors seek expansion and rent more space to accommodate increased workforce. The lodging/resort REITs too will likely be on the winning side, as business travel benefits from rising corporate profits and corporate tax cuts, as well as a healthy business investment, while leisure travel may ride well on low unemployment level and rising wages.
Elevated Deliveries of New Units and Trade Policies: Nevertheless, despite an improving economy and robust job growth, rising delivery of new units in several asset categories, such as industrial, office, senior housing and self-storage, has kept REITs on tenterhooks. Rising construction with increased completions are moderating landlords’ ability to command more rents and grow occupancy levels, and resulting in high concessions as well.
Therefore, slowdown in leasing velocity and compression in rent growth will likely remain causes of concerns in the near term. In addition, any protectionist trade policies will have an adverse impact on economic growth, and affect the business of industrial REITs over the long term. For data-center REITs, aggressive pricing pressure and substantial debt burden are likely to limit growth tempo.
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 #111, which places it at the top 44% 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 bright 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 Outperforms Sector, S&P 500
The REIT and Equity Trust – Other Industry has outperformed the broader Zacks Finance Sector, as well as the Zacks S&P 500 composite over the past year.
The industry has registered a fall of 6.4% during this period compared with the S&P 500’s decline of 7.8%. Meanwhile, the broader sector has registered a fall of 15.5%.
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 Residential REITs, we see that the industry is currently trading at 14.7X compared to the S&P 500’s forward 12-month price-to-earnings (P/E) of 15.4X. However, the industry is trading above the Finance sector’s forward 12-month P/E of 12.4X. 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 18.9X, as low as 14.2X, with a median of 16X.
Bottom Line
In a nutshell, the REIT – Other industry is poised for growth amid economic recovery and job-market growth, favorable demographics, technological developments and lifestyle transformations. Nonetheless, delivery boom in certain asset classes in the near- to mid-term may strain rental rates and result in high concessions. Further, with persistent hikes in interest rates, companies are anticipated to witness rise in financing costs as well.
In addition to the above, REITs have extended the average maturity of their debt to longer terms, locking in previous low interest rates. 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 Zacks Rank #1 (Strong Buy) that investors may consider adding to their portfolios.
You can see the complete list of today’s Zacks #1 Rank stocks here.
Headquartered in Uniondale, NY, Arbor Realty Trust, Inc. (ABR – Free Report) is a REIT and direct lender that specializes in loan origination and servicing for multifamily, seniors housing, healthcare and other diverse commercial real estate assets. Arbor Realty delivered average positive surprise of 15.16% in terms of FFO per share, over the past four quarters. Moreover, the stock has seen the Zacks Consensus Estimate for 2019 FFO per share being revised 4.4% north in two months’ time.
New York-based Global Net Lease, Inc. (GNL – Free Report) focuses on acquisition and management of industrial and office properties leased for the long term to quality corporate tenants in select markets in the United States and Europe. It generated average positive surprise of 3.36% in terms of FFO per share. Estimate revision activities have been decent, with the first-quarter 2019 FFO per share estimate moving north 5.8% to 55 cents over the last 60 days.
Great Neck, NY-based One Liberty Properties, Inc. (OLP – Free Report) is engaged in acquisition, ownership and management of a geographically diversified portfolio, comprising mainly industrial, retail, restaurant, health and fitness, and theater properties. Several of these properties are subject to long-term net leases. The stock’s Zacks Consensus Estimate for 2019 FFO per share has been revised 1.4% upward to $2.17, over the last 60 days.
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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