REITs To Bounce Back In 2018 Following This Year’s Lagging Performance

Publicly traded REIT yields have underperformed the broad stock market this year, causing some to question the market’s resiliency. But industry experts foresee returns bouncing back in 2018.

As of Dec. 5, year-to-date returns on the FTSE NAREIT All REIT Index stood at 8.1%, while S&P 500 yields averaged 19.69% year-to-date.

Though the discrepancy is wide, National Real Estate Investment Trust Economist Brad Case said any hesitancy on investors' part and concern about future REIT performance is unwarranted.  

“The idea that [REITs] have lost their appeal doesn’t make any sense at all,” Case said. “Investors always need to be thinking about what’s going to happen in the future. As the economy improves, you’re going to see strong real estate operating fundamentals, which means you want to own real estate while that’s happening. You don’t want to wait until returns are high to invest."

Case also said there is an apparent divide between current REIT stock prices and the value of their assets and overall portfolios, which means there is room for growth, and investors have an opportunity to pick up REIT stocks at a discounted price.

This disparity between stock prices and net asset values has been exacerbated by rising interest rates and varying sector fundamentals, which Case attributes to a disconnect between investors’ fear of higher rates and how REITs historically perform in a rising interest rate environment. 

“The economy is getting stronger and there’s no question about that. If the economy gets stronger then the Fed will allow interest rates to go up. That’s good news for real estate investors. When the economy is stronger, people demand more office, industrial space and hotel rooms. This tends to [lead] to higher occupancy rates and stronger rent growth,” Case said.

Another headwind hindering REIT investment is the rise of activist investors, according to Deloitte’s 2018 Outlook report. REITs have been a popular avenue for real estate investment since their founding in the 1960s. Of the 225 publicly traded REITs on the market, which own an estimated $2 trillion worth of assets, 32 are traded on the S&P 500, according to NAREIT.

But as the industry has matured, investors have grown increasingly comfortable with real estate as its own asset class, spurring more activism and investor involvement. This can take shape in the form of more generalist investors that are not overly familiar with real estate asking questions and delaying deals due to varied or unrealistic performance expectations, Deloitte U.S. Head of Real Estate and Construction Jim Berry said.

“Our report focuses on the need for companies in the real estate industry to revisit their corporate governance and communication strategies in order to address these potential hindrances to REIT investment,” Berry said. “Real estate companies must not only consider ‘what,’ but also ‘how’ to communicate with investors, which may include the development of strategies involving other social media communication channels.”

Projecting Future REIT Values

Despite REITs' sluggish performance this year, Case is optimistic the market will buck the trend moving into 2018.

“One thing worth pointing out is that REITs house the economy and 2018 is likely to see an improvement in the economy,” Case said.

There are several ways investors can project future REIT return performance, Case said, and it all boils down to dividend yield spreads and historic data.

By comparing REIT dividend yields to the returns of other fixed income securities, such as the 10-Year Treasury or corporate bonds, investors can estimate how REITs will perform moving forward based on how they performed in the past during similar economic situations. 

Take corporate bonds as an example. At the close of Nov. 24, the average yield for corporate bonds was 4.24%. That same day, the average yield for equity REITs, according to the FTSE NAREIT All Equity REIT Index, was 3.85%. That represents a 0.47% spread.  

“Historically, when the spread was 0.5% or less, over the next two years equity REIT returns averaged 22.4% per year and outperformed the broad stock market,” Case said. 

Discrepancy In REIT Performance

Though overall equity REIT yields are not keeping pace, there are several REIT sectors that have experienced above-average yields this year.

Apartment, office and retail REITs are the year’s weak links, averaging 4.26%, 3.09% and -8.11% in returns, respectively. Retail REITs in particular have suffered as asset managers battle an ongoing negative perception that the retail industry as a whole is headed down the drain.

On the flip side, infrastructure REITs boast the largest returns year-to-date of 32.64%, and data center REITs are not too far off with year-to-date yields of 26.17%.

Industrial REIT returns are sitting at 20.68% year-to-date. The sector remains red-hot and is breaking records left and right thanks to the growth of e-commerce and warehouse users expanding into urban metros to be closer to consumers. 

“We remain optimistic about the outlook for real estate overall as a long-term driver in our economy,” Berry said. “While there are differences between how certain real estate sectors have performed, the continued strength in base economic fundamentals continues to drive increasing values and therefore opportunities for strategic development or redevelopment and the repurposing of assets.”