REITs for an Uncertain Environment

He cites retail shopping centers anchored by stores that serve everyday consumer needs as an example. Examples of these anchors include Publix supermarkets and mid-sized tenants, such as a T.J. Maxx, Marshalls and Target.

The retail REITs Martin suggests focusing on include Realty Income (O) and Federal Realty Trust (FRT). “Many of FRT’s shopping centers are anchored by either the leading grocer in a market or a value retailer,” he said. “That, again, is serving everyday consumer needs and focused on value. They benefit from some very, very strong locations in urban infill markets. So, there’s very little competition from new development projects.”

REITs with healthcare companies and labs as tenants are another defensive sector because healthcare is less tied to the economic cycle. Healthcare and lab-space REITs cater to the large biotech and pharma companies like GlaxoSmithKline, Novartis and Johnson and Johnson. Alexandria Real Estate Equities Inc. (ARE) is an example of a healthcare REIT that Martin likes. “Alexandria is our favorite in that sector,” says Martin. “Alexandria has key life-science clusters in, for example, South San Francisco, La Jolla, and Cambridge. Internationally they have a first-mover advantage in India and they really align themselves with not only the local universities such as Stanford and San Francisco, but they’re also full integrated with the healthcare systems, the venture capital, other biotech firms. They are the go-to landlord, developer, and owner of those assets.”

Martin also favors multifamily REITs. Although share prices have increased significantly over the past several years and valuations are “a bit stretched from a fundamental standpoint,” the sector still makes sense, he believes: “We’re seeing a significant amount of (housing) demand for a number of reasons. Number one, it’s a very cost efficient housing alternative, especially in an environment where there’s a lot of uncertainly around home ownership where evaluation is settling out and there’s a lot of supply. It’s been very, very difficult to get a mortgage, so mortgage financing is very difficult. That leads to a tremendous amount of uncertainty. On top of that you have a levered balance sheet from the average consumer. All of that is creating significant demand and I would call it outsized demand for multifamily at a time when we don’t have a significant oversupply of multifamilies. It has driven valuations so we’re seeing very good rent growth in the 5 to 10 percent annual basis for the multifamily REITs.”

The REIT’s management team is another key factor in a slow-growth environment. Martin says. In particular, he wants to see what he calls a “full service real estate skill set,” which he defines as the ability to acquire, develop, redevelop and manage property. These businesses, he says, “are able to grow or have flexibility through a cycle, whether that’s an economic cycle, slow growth or high growth or whether that’s an inflation cycle or whether that’s just a real estate or financial cycle.” Another factor to consider if interest rates rise: the REIT’s finances. “We want to focus on those companies with strong balance sheets where leverage isn’t too high, where interest coverage ratios are in good shape, where debt maturity levels on an annual basis are at a manageable level,” he says.