The bond market was closed on Friday, keeping rates in check and allowing REITs a respite from the week's bout of selling. The respite was short-lived though, with the selloff resuming this morning as the 10-year Treasury yield jumps 10 basis points to 2.255%.
Realty Income (O -1.5%), Public Storage (PSA -1.3%), Welltower (HCN -0.6%), Equity Residential (AVB -1.6%), AvalonBay (AVB -1.6%), Simon Property (SPG -1.5%), Kimco (KIM -0.5%), Eastgroup (EGP -0.5%), American Campus (ACC -1.7%).
Fading the action are some office REITs as players eye a big boost in government spending: Government Properties (GOV +1.6%), Boston Properties (BXP +1%), First Potomac (FPO +1.2%).
Also fading the negativity despite the stronger dollar are the previously very roughed-up lodging REITs as perhaps they discount a stronger economy: Ashford Hospitality (AHT +3.7%), Sunstone Hotel (SHO +3.2%), LaSalle Hotel (LHO +2.2%), Pebblebrook Realty (PEB +3.7%), Summit Hotel (INN +1.6%), Hospitality Properties (HPT +1.2%), RLJ Lodging (RLJ +2.8%)
Now it's the team at Evercore ISI, and analyst Steve Sakwa says the "noisy" Q3 earnings season has created buying opportunities, with AFFO multiples at their lowest since Dec. 2013, and implied cap rates about 400 basis points above the 10-year Treasury yield (vs. a typical 320 bps).
Noting either strong fundamentals or attractive valuations, he's a fan of Paramount Group (PGRE +0.2%), General Growth (GGP +1.5%), Vornado (VNO +0.9%), Prologis (PLD +1.4%), CubeSmart (CUBE +1.8%), Brixmor (BRX +0.7%), Life Storage (LSI +2%), Simon Property (SPG +0.3%), Mack-Cali (CLI +1.2%).
Interest rate fears have helped send REITs tumbling over the past few months, with the Vanguard REIT Index ETF (NYSEARCA:VNQ) down from 15% from its July high, and now yielding 4.3% - more than double that of the S&P 500.
Notable REITs at 52-week lows include Equity Residential (NYSE:EQR), Macerich (NYSE:MAC), Simon Property Group (NYSE:SPG), and Public Storage (NYSE:PSA).
Green Street's Mike Kirby: REITs aren't pound-the-table inexpensive, but on the attractive side of fair value. Citigroup: "While there is undoubtedly deceleration in fundamentals ... the REIT sector is in its best shape from a balance-sheet, portfolio, and operations perspective in its history.”
Negatives include too much apartment supply in formerly hot markets on the coasts, a flattening in Manhattan office rents, and pressure on malls from the boom in e-commerce.
Even with all that, Kirby sees the industry's AFFO rising 6.3% this year, and 7% in 2017 and 2018. REITs trade at 20x forward AFFO - pricey vs. the S&P 500, but worth it if they produce better profit growth.
Another valuation method is to look at the cap rates of portfolio properties, and a check finds REITs like Boston Properties (NYSE:BXP), and Simon Property are selling below their private-market values. Why, asks Kirby, would a pension fund or sovereign wealth fund pay a higher price (lower cap rate) for a Manhattan property when they could get a whole portfolio of NYC office buildings at a cheaper valuation by buying SL Green (NYSE:SLG)?
The 10-year Treasury yield is making new bear-cycle highs today, up another seven basis points to 1.86% - its perkiest level since May. The move up in yields is global, with U.K. 10-years up 11 bps and Germany's up 8.5 bps.
Facing at least a little more competition in the yield department, equity REITs have turned sharply lower, with VNQ down 2.1%, and IYR off 1.8%. Mortgage REITs (REM -0.6%) are faring a little better as solid Q3 earnings begin to roll in.
The major U.S. averages have given up early gains and turned red, led by the S&P 500 and Nasdaq, both off 0.25%.
Individual equity REITs: Verreit (VER -2.2%), Welltower (HCN -2.4%), Equity Residential (EQR -1.6%), Omega Healthcare (OHI -3.2%), Simon Property (SPG -3.2%), General Growth (GGP -2.6%), Public Storage (PSA -2.9%), Gramercy Property (GPT -1.9%), Washington Real Estate (WRE -1.2%), Hersha (HT -2.9%), Sunstone Hotel (SHO -1.4%), Stag Industrial (STAG -2%)
While the VNQ was up 1.8% today, the ETF and sector has been in a bit of a downtrend since the end of July. Why?
It seems to be tied to the chance of Fed rate hikes, says Wells, and the higher-yielding segments of the sector have had an especially rough go of it. There's also the realization that fundamentals have been softening over the past year.
"We favor taking some profits off the table and reallocating to asset classes we believe have better risk/return tradeoffs."
Today is the day (after the close) when REITs are officially broken out of financials and into their own sector, but that's not necessarily a reason to rush to buy, says BMO Capital Markets, initiating coverage of the new sector with a Neutral rating.
While the reclassification could boost asset flows, a big run-up already this year has left REITs with a fancy valuation at a time when rates might be set to begin a material move higher.
The Vanguard REIT ETF (NYSEARCA:VNQ) is up 14% YTD, but has fallen about 8% over the past handful of sessions as interest rates have climbed sharply.
As of the close today, equity REITs will be broken out of the S&P financial sector where they currently reside, and into their own category - that's 28 stocks with nearly $600B in market cap.
The real estate sector will account for about 3% of the total S&P 500, while financials - which account for about 13.1% - will drop below 12%.
In front of that, investors put $1.08B into REIT ETFs in August alone and $7.6B year-to-date. Of course, this could have less to do with the new sector, and more to do with performance chasing - REITs have far outperformed the broader indexes this year. The biggest beneficiary is the $34B Vanguard REIT Index Fund (NYSEARCA:VNQ) which has pulled in $4.57B.
It's smelling like a top in real estate to Laszlo Birinyi, who wonders why investor interest and outperformance is enough to merit a separate S&P classification for REITs (specifically, equity REITs; mortgage REITs will remain in the financials).
He compares the move to the the decision to add Apple to the DJIA after its near-1000% rise from the March 2009 bottom. Since, Apple is the worst-performing name in that index, with a total return of negative 12.9%.
Up 348% from the 2009 bottom, REITs are trading at 45x earnings - "not a compelling purchase," says Birinyi.
Besides, says Birinyi, there are plenty of ETFs out there through which investors can already get easy exposure to REITs. This move, he says, is about benefitting S&P, which should be able to earn licensing fees from the funds.
Funds from operations for the equity REIT industry rose 7.1% for the quarter and were up 10.3% on a year-over-year basis, according to NAREIT. NOI gained 5% for the quarter and 9.1% Y/Y. Dividends of $12B were up 13.6% from Q2 one year ago.
Same-store NOI was up 4.3% Y/Y, with self-storage and data centers showing particular strength.
On a per share basis, FFO rose 5.5% Q/Q and 2.9% Y/Y; NOI gained 3.5% and 1.7%, respectively.
Despite REITs having delivered far better total returns than the S&P 500 over virtually any time frame from the last three decades, fund managers continue to underweight the group, often chalking up the outperformance to little more than the epic bond bull market.
Cumulative indexed profits from REITs over the last two decades have been 20% higher than what the S&P 500 delivered, according to the report. "Superior operating results ... has translated into market-beating total returns."
REITs could fare even better in the future, suggests Green Street. First, profit growth this decade has been hurt by heavy dilution thanks to too much leverage pre-crisis - a lesson REIT managers have learned. Second, profit margins in the S&P 500 are near all-time highs, but the same can't be said for REITs. Finally, REIT portfolios are higher quality than in the past, which should mean improved long-term growth.
What it found was that listed equity REITs outperformed all other 11 asset classes in the study, with average annual net returns 11.95%. Private-equity was second at 11.37%, pulled down by management fees nearly four times higher than that of REITs.
The average annual cost for public REITs of 0.51% was the lowest of any alternative or real estate asset groups.
Hedge funds had average annual costs that were double those of REITs, and produced just half the net returns at 5.5%.
Curiously though, allocations to hedge funds skyrocketed during the study period, while those to REITs stayed about flat. Putting numbers on it, hedge fund allocations grew to 8.36% from 1.46%, while listed REIT allocations of 0.62% edged up from 0.36%.