REITs Are Rebounding... Kind Of

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Includes: DRA, DRN, DRV, FREL, FRI, FTY, IARAX, ICF, IYR, JRS, KBWY, LRET, NRO, PSR, REK, RFI, RIF, RIT, RNP, RQI, RWR, SCHH, SRS, URE, VNQ, WREI, XLRE
by: Hightower

By Billy Fink

U.S. real estate investment trusts (REITs) had a wild ride last year. Uncertainty about rising interest rates, China's economy, and the collapse of oil prices all made for an interesting 12 months.

Overall, U.S. REITs ended fairly flat compared to the upward trajectory of the past few years. The thought among some analysts is the sector will see modest growth this year.

A rocky 2015

Overall performance of publicly traded U.S. REITs was rocked by volatility last year - along with the overall stock market - as investors anticipated rising rates, among other things. CNBC reported in December the MSCI REIT Index dropped from a peak of 1,230 in January to 1,085 in December.

But, things seem to be changing. "The climate of fear seems to have abated. REIT fundamentals are good, the demand side of the equation is decent and there's not that much new supply," Rich Moore, managing director at RBC Capital Markets, told the National Association of Real Estate Investment Trusts earlier this month.

Total returns of stock exchange-listed REITs fell in the first two months of 2016, but still outperformed the broader market. The FTSE NAREIT All REITs Index, which tracks equity and mortgage REITs, declined 3.76 percent for the year through Feb. 29. The S&P 500 Index fell 5.09 percent in the same period, NAREIT said.

U.S. REITs have experienced returns in the range of 8.5 percent to 12 percent from 2011 to 2015, with last year as the weakest performer, Kenneth Leon, global research director, equity research at S&P Global Market Intelligence told Hightower.

Current standings

As of March 20, 2016, U.S. REITs returned 12.8 percent in 2011, 8.6 percent in 2012, 10.5 percent in 2013, 8.9 percent in 2014 and 7.3 percent last year, according to data from S&P Global Market Intelligence.

Another key measure of REIT performance is free funds from operations (FFO) growth, which focuses on a REIT's net income, excluding gains or losses from sales, but including depreciation, according to NAREIT. FFO growth in 2011 was 21.9 percent, 2012 was 11.4 percent, 2013 was 16.9 percent, 2014 was 19.2 percent and last year was 14.1 percent, according to S&P Global Market Intelligence.

"We expect FFO growth will still be mid-to-upper single digits in 2016, even with lower investment growth of properties," Leon said. This year, the fundamental economy appears stable and that bodes well for solid performance for U.S. REITS.

"If you step back and look at what is happening on the operations side, you see a pretty solid economy, albeit possibly slowing down in the near future," said Edward Mui, an equity analyst with Morningstar who focuses on REITs. "That's what I'm looking at when I look at real estate - what is the underlying operations of all these guys' tenants, their access to capital?"

However, investors still seemed spooked by uncertainty, which is keeping people cautious. "We're still in a period of uncertainty and volatility. People are trying to read the tea leaves now that haven't settled and might not settle for the next two or three years," Mui said.

Outlook for the rest of the year: A flight to quality

That caution plays into where investors choose to put their money. Mui said there has been a flight to quality among many investors, with well-established managers reaping the benefits. Investors have been "looking for companies that have proven themselves pretty solid through economic cycles, guys with long term leases in place, guys who can pay steady dividends," Mui said.

That flight to quality could also pertain to specific property types. Stable property-types include multi-family, storage and industrials, Leon said. Weaker property categories include healthcare, hotel and retail.

Hotels suffer from a strong U.S. dollar, which limits personal and business travel from abroad, Leon said. Also, an increase in hotels and rooms is pushing the property category into an excess of supply. "That puts downward pressure on hotel rates," Leon said.

Healthcare, on the other hand, is impacted by issues fundamental to the industry. The main factor is the government funding through the Affordable Care Act. ACA benefits some portions of the industry and has put pressure on other parts. Post-acute hospital care, rehabilitation and other types of senior care both benefit from ACA, Leon said.