REITs Are Outperforming, but Some Sectors Are Stronger Than Others

Baby boomers and millennials, trendsetters in different ways, are both driving growth in key REIT sectors

This year, musings about Fed interest rate increases are making markets wary, yet one of the strongest sectors is real estate investment trusts, which traditionally doesn't outperform when rates are rising or expected to rise.

in addition, REITs are expected to to get an extra boost this year in recognition of the Sept. 19 separation of real estate from the Standard & Poor's financial category and the creation of its own S&P sector. Still, that might be the least of the positive fundamentals driving this asset class. Year to date, REITs overall are up about 11.56%, while the S&P 500 is up about 7%.

(Related on ThinkAdvisor: Real Estate to Become Its Own S&P 500 Sector)

“In the last several years of declining and low interest rates and active and receptive bond and equity markets, REITs have taken advantage of that and have refinanced their balance sheets so they’re almost bulletproof,” says Ashi Mathur, BMO head of investment and corporate banking for North American real estate.

“They’ve de-risked their business by creating longer term ladders so there’s no bulging maturity in any one year; they’ve got much flatter schedules, so each year only 10% of debt might be coming due, and that’s a huge advantage.”

In addition, REITs are “run by entrepreneurs who have been in the industry a long time and have been able to capitalize on opportunities … The capital markets have been supportive and investors continue to have a thirst and hunger for yields. Not many sectors can boast the yields that REITs have provided over a consistent period of time. It’s an attractive sector,” he adds.

Edward Mui, a Morningstar equity analyst, agrees. “It’s a combination of the underlying performance of the properties still being relatively healthy and the characteristics of the investments, where REITs provide yields that a lot of investors can’t find elsewhere for reasonable prices,” he says.

Mui notes that the Fed’s action – or lack thereof – in raising interest rates has lengthened the outlook. “Clearly it’s possible the Fed may increase interest rates sometime this year, but the long trajectory of those rate increases still is on the lower side of where people were at the beginning of year."

When looking at REITs, both experts noted that health care and multi-unit housing are two key areas of strength.  Mathur highlights the aging population in the U.S. and Canada, which means high demand for senior housing that should continue to grow.

Mui says Morningstar likes health care real estate “as a whole.  We still like property sectors embedded in long-term demand like health care real estate,” he says. “On top of that you have the operational expertise you really need to succeed in the space; health care is operationally intense, you need to know the business and demand drivers and successfully navigate the regulatory environment, which is still in transition.”

Both see rental properties in strong growth urban areas, such as New York, Los Angeles and San Francisco, to maintain strength, largely due to the millennial generation.

“Millennials like to live, play and work in same area,” Mathur says. “This impacts how offices are built, even how retail space is used. There are more gyms, restaurants, daycare centers, doctors’ offices, grocery stores in an area. The shift is taking place and it’s impacting retail [especially with the internet and urbanization].”

Mui points out that “rental housing has been in an extended strong six-to-eight year” upward trend largely due to the millennial population “that is the core rental population but also a …  generation [that] is generally pushing back major life decisions, renting longer, having more mobility, all which drive rental housing.”

Mathur cautions this isn’t true in all markets; for example, Houston and Calgary have been affected overall by the energy market’s weakness, which means higher vacancy rates.

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