After examining the effects of higher rates/yields periods on mortgage REITs, it's time to do the same drill with equity REITs.
Unlike mREITs that have shown mixed effects, eREITs suppose to react less favorably to periods of increasing rates/yields.
Assuming that we are about to see higher rates/yields in 2017, this analysis should provide a good indication how different types of eREITs are expected to perform.
Since the numbers and types of eREITs are far greater than those of mREITs, each article will focus on different type of eREITs.
This article is focusing on large-cap malls and shopping center eREITs.
Last month, I prepared an analysis regarding the performance of mortgage REITs (REM, MORL), "mREITs" hereinafter, during periods of increasing rates and yields. In total, I've covered 40 names across four different types (of mREITs): Commercial, Residential, Hybrid/Special and Traditional/Agency. The main findings when it comes to mREITs' performance during increasing rate and yield periods were:
- While the performance of the sub-groups varied, commercial mREITs - e.g. ARI, LADR, STWD, BXMT (the first three names are part of my A-Team) - have outperformed the other sub-groups.
- A few selective names (NRZ, ARI, BXMT, STAR) have continuously and consistently outperformed.
The mREITs analysis was not only comprehensive, but it also assisted me in arranging my own thoughts and views in regard to both past and future actions that I took/need to take when it comes to various mREITs that I held/hold.
As such, I believe that just as the coverage of mREITs was useful in better understanding the resilience of mREITs to higher rates/yields, it can be beneficial to run the exact same analysis with eREITs. Not only because I believe mREITs are better positioned than eREITs, but also especially since I believe that many eREITs are overvalued, and as a result, I have short positions in more than a handful of those - short positions that are part of my H-Team.
Here is a list of the sub-groups that already been covered:
Part I: Residential eREITs
Part II: Data-center and storage eREITs
Part III: Small-cap (*) hospitality eREITs
Part IV: Large-cap (**) hospitality eREITs
Part V: Large-cap (**) healthcare eREITs
Part VI: Small-cap (*) healthcare eREITs
Part VII: Industrial eREITs
Part VIII: Triple-Net Lease eREITs
Part XIII - the one you're currently reading - focuses on Specialized Diversified/Hybrid and Leisure ("S-DH&L" hereinafter) eREITs.
(*) Small-cap = Below $3 billion market cap
(**) Large-cap = Above $3 billion market cap
If you are a regular reader of this series, you may move on to the "The Unavoidable Linkage Between eREITs and Credit Spreads" section
eREITs: A Much Bigger and More Diversified Universe than mREITs
There are ~x6 more eREITs than mREITs. There is also far greater diversification within the eREITs arena than within the mREITs limited space. As such, it doesn't make sense technically (too long) and fundamentally (too different) to cover the eREITs arena altogether in a single article. Therefore, I'm cutting the eREITs analysis into smaller parts/articles; each part/article focuses on a different type of eREIT.
Before presenting the list of the eREITs that will be part of the analysis, there are few important clarifications that need to be made:
- Companies with a market cap <$100 million and/or an <18-month track record were automatically "disqualified."
- The classification of the groups has been done on a "best effort" basis. In more than a few cases, companies could easily be placed in more than one group. Nonetheless, even in cases where a company fits more than one group, it was placed within the group that most closely characterized it, to my best judgment.
- When applicable (only for three types of eREITs) and for the purpose of this specific analysis, the $3 billion mark is what distinguishes between large caps (>$3 billion) and small caps (<$3 billion).
The original list of all the 120 eREITs that are part of this analysis can be viewed in previous articles, parts I-VIII, inclusive.
Along the way, and as more and more articles were added, I received few requests from readers to include additional names, mostly specialized eREITs, in this series of articles. As such, I've decided to "take (not only one but) two for the team" and to expand this into a 13-part series.
The two extra parts will see the "specialized eREITs" sub-group breaking up into three (separate parts): Commodities-Related & Housing, Government-Related & Infrastructure and Diversified/Hybrid & Leisure.
Due to this expansion, the total number of eREITs (and eREITs-like proxies) that are being covered in this series went up from 120 to 146 as of now. This number may increase should I receive additional names, especially for the last two sub-groups, i.e. parts XII and XIII, that currently only contain nine and six names, respectively.
The 146 eREITs are spread out across 13 different types of eREITs (including three types that were separated into large and small caps due to the large number of companies and/or wide range of market caps within the specific classification).
While, as mentioned above, a few names may belong to more than one type, I believe the classification is both comprehensive and representative; it's a well-balanced, diversified reflection of the eREITs segment as a whole, as well as an accurate-focused mixture of names within each type of eREIT.
In total, we now have 13 sub-groups of eREITs (sorted according to order of publication):
- Residential (12 names): AIV, APTS, AVB, BRG, CPT, EQR, ESS, IRET, IRT, MAA, UDR
- Data-center and storage (11 names): CONE, COR, CUBE, DFT, DLR, EQIX, EXR, IRM, NSA, PSA, QTS
- Hospitality, Small-Caps (10 names): AHP, AHT, CHSP, CLDT, DRH, FCH, HT, INN, PEB, XHR
- Hospitality, Large-Caps (7 names): APLE, HPT, HST, LHO, RHP, RLJ, SHO
- Healthcare, Large-Caps (9 names): ARE, HCN, HCP, HR, HTA, MPW, OHI, SNH, VTR
- Healthcare, Small-Caps (9 names): CCP, CHCT, CTRE, DOC, LTC, NHI, SBRA, SNR, UHT
- Industrial/Commercial (13 names): DCT, DRE, EGP, FR, GOOD, GPT, LPT, PLD, PSB, REXR, STAG, TRNO, WPC
- Triple-Net Lease (12 names): ADC, EPR, FCPT, GNL, LXP, MNR, NNN, O, OLP, SRC, STOR, VER
- Malls & Shopping-Centers, Small-Caps (12 names): AKR, CBL, KRG, PEI, ROIC, RPT, SRG, UBA, UE, WHLR, WPG, WSR
- Malls & Shopping Centers, Large-Caps (13 names): BRX, DDR, EQY, FRT, GGP, KIM, MAC, REG, RPAI, SKT, SPG, TCO, WRI
- Specialized, Commodities-related & Housing (12 names): CORR, CTT, ELS, FPI, HASI, HIFR, LAND, PCH, RYN, SUI, UMH, WY
- Specialized, Government-related & Infrastructure (12 names): ACC, AMT, CCI, CSAL, CXW, DEA, EDR, GEO, GOV, LMRK*, SBAC*, USM*
- Specialized, Diversified/Hybrid & Leisure (14 names): ABR, ANH**, BPY*, CLNS, CMCT, GLPI, KBWY*, JCAP**, LAMR*, MYCC*, OUT*, RMR*, RWR*, SLD
(*) Technically, not a REIT but it is a real-estate and/or infrastructure services provider, i.e. close enough to be operating or at least be viewed as a REIT in essence.
(**) Technically, a mortgage-REIT but a special, more diversified, mREIT in essence. Those are mREITs that operate quite similarly to a "pure REIT."
Over the past five years, we have witnessed three periods of rising rates/yields:
- Period I: 4/26/2013-12/27/2013
- Period II: 1/30/2015-7/3/2015
- Period III: 7/8/2016-12/15/2016
For each type/classification of eREITs, there are three charts that show the performance of the relevant group of companies during the three periods - three charts per group, one chart per period.
Then, the average return for each group during each period was calculated in three different ways:
- Average based on all the observations (of all the companies that were publicly traded) during the period.
- Average that excludes the best and worst observations that were recorded during the period.
- Median or average of the median (if it comprises two observations).
By excluding the best and worst, we "soften" the "bumps" that may occur due to specific/extreme news/events that may have affected a certain company. In other words, we avoid temporary "noise."
After receiving three different averages, I calculated an equal-weighted average for all three averages. By doing so, I believe the data is more reliable and less affected by temporary specific news, events or returns that one or two companies may have gone through the examined period.
Bear in mind that this is a relative drill - an attempt to point out at specific types and names of eREITs that perform more or less favorably during periods of higher rates/yields. Therefore, more than an accurate mathematical-scientific result, I'm mostly interested in presenting the trends and the different performances of various types of eREITs. That way, we will be able to draw better conclusions regarding each sub-group's relative strength compared to other sub-groups within the eREIT segment.
Before presenting the charts for the specific eREIT sub-group that this article is focused on, it's worthwhile taking a closer look at how the main best comparable ETFs have performed during the three periods (of higher rates/yields) that we examine.
Here is how the Vanguard REIT Index ETF (NYSEARCA:VNQ), the iShares U.S. Real Estate ETF (NYSEARCA:IYR), the US Treasury 10-Year and 30-Year yields (UST, TLT, TLH, PST, TBF, TBT) and the SPDR S&P 500 Trust ETF (NYSEARCA:SPY) performed during the relevant periods:
- Period I: 4/26/2013-12/27/2013
- Period II: 1/30/2015-7/3/2015
- Period III: 7/8/2016-12/15/2016
As we can see, during periods of higher rates/yields, the real estate-related ETFs (VNQ, IYR) performed poorly. That is true in both absolute terms, i.e., negative returns, and relative terms, i.e., outperforming SPY.
Clearly, this should come as no surprise to anyone. I wrote a couple of times about the relationships between rates/yields to eREITs prices; while the former move was higher, the latter move was lower.
This fact only makes the analysis even more challenging/intriguing, because knowing that eREITs underperform during period of increasing rates/yields, the real question is: Can we find specific names that may strive while most, if not all, of their eREIT peers suffer?
The Unavoidable Linkage Between eREITs and Credit Spreads
Most REITs have a sub-IG rating. As a HY-rated segment, yields of REITs suppose to reflect their rating, i.e. (default) risk. I claim(ed) that the current yields many eREITs offer don't reflect the appropriate levels of risk (not only default) and uncertainty. Putting it differently, eREITs' dividend yields don't trade in tandem with their respective credit rating.
Take a look at HY spreads over the past year:
Source: Bespoke Investment Group
And if you think the IG-rated credits look much better, you're wrong. See for yourself:
In more simple words, current spreads/yields neither reflect the real risks out there nor are they sustainable on both fundamental and historical perspectives. And in case I wasn't clear enough before, I wish to add that eREITs are no different.
Credits Are Much More Reliable Whistle-Blowers Than Equities
It's well known that credit markets are trading ahead of equity markets. Almost all major market corrections/crises have been preceded with widening spreads of IG-rated debts.
Take a look at Morgan Stanley's (NYSE:MS) right-to-the-point chart below:
As you can clearly see, the two biggest crises of the 21st century - namely the burst of the tech bubble in 2000 and the sub-prime crisis in 2008 - were preceded by IG-rated spreads moving higher and higher.
Once spreads on IG-rated debts reach the level of about 100-120bps (over the benchmark US Treasuries yield curve), you know that things have got stretched - too stretched. Now go back to the previous chart (Exhibit 6 by WFC) and see where IG spreads are currently at. Hint: Do you feel stretched?...
True, one can claim that based on the MS chart, we may need to wait for IG spreads to (first) start widening (from where they bottom), and (only) then we may have another 12-18 months until equities respond to the "stretched message" they've been given by credits.
I view this as "playing with fire" and possibly an attempt to "perfectly time the market." It's one thing to try timing the market, but to try and time it as perfectly as the above chart implies is, well, too stretched (even) for my taste. Personally, when I see a macro phenomenon such as this, I adhere to strict risk management procedures. I don't wait for the tornado to hit my house in order to renew my insurance policy. Similarly, I don't wait for the tornado to hit my house in order to make the necessary preparations as well as to ensure that my safe shelter is in good condition, set and ready to absorb the implications of a (powerful) tornado that might be on its way towards me.
If this weren't enough, take an even closer look at the below chart, where you can the difference in volatility levels between long-term US Treasury debts and the S&P 500 index over the past 20 years:
In more simple words, while the volatility levels in the credit markets are soaring, those in the equity markets are at record lows.
Taking into consideration that January 2017 had seen one of the narrowest-ever trading range for the S&P 500, it seems like we have an almost perfect set-up for the market to move sharply (in either direction) from here. Where to? I'll leave that guess to you. Personally, as anyone who read my previous pieces (here and here) knows, I'm very cautious (not a "full-size bear," though!), and my portfolio is structured accordingly. I'm currently running about half a dozen long-short themes/strategies simultaneously; perhaps I'll touch upon this in a separate article (following the end of this series), but the main message I wish to deliver is: Watch out the macro environment very closely and remain very mindful of risk management. Protect your capital at all costs!
The next part of this series, Part XI, will focus on specialized commodities-related & housing eREITs.
Stay tuned and don't lose focus!
S-DH&L eREITs - Charts and Analysis
Since this sub-group contains few of the eREITs with the largest market cap, and in order to avoid presenting charts that are "too crowded" with data, I've decided to present two charts for each of the three examined periods:
- The first chart shows the performances of the S-GR&I eREITs with the largest market caps, i.e., market cap >$3 billion.
- The second chart shows the performances of S-GR&I eREITs with a market cap that is <$3 billion.
Chart 1 and 2: S-DH&L eREITs, 4/26/2013-12/27/2013
Chart 1: S-DH&L eREITs with market cap >$3bn
(*) Please note that this chart contains no data regarding OUT and GLPI because these stocks started trading only during/post the examined period.
Chart 2: S-DH&L eREITs with market cap <$3bn
(*) Please note that this chart contains no data regarding JCAP, MYCC and RMR because these stocks started trading only during/post the examined period.
- Average including all observations: -4.84%
- Average excluding best and worst observations: -4.82%
- Median: -7.60%
- Average performance of all three averages: -5.75%
Nothing special from the S-DH&L eREITs during the first examined period of rising rates/yields.
Seven out of nine observations were negative with only two names - CMCT (17.04%) and LAMR (9.54%) posting positive returns.
The three large caps, with an average total return of -1.49%, outperformed the smaller caps that posted a -7.53% total return on average. This ~6% gap is quite substantial.
With a range (between best to worst performers) of ~19%, the large caps were also much less volatile than the smaller caps with a range of ~44%.
CMCT (17.04%) was the clear outperformer while ANH (-26.9%) was the clear underperformer during this period.
Chart 3 and 4: S-DH&L eREITs, 1/30/2015-7/3/2015
Chart 3: S-DH&L eREITs with market cap >$3bn
Chart 4: S-DH&L eREITs with market cap <$3bn
(*) Please note that this chart contains no data regarding JCAP and RMR because these stocks started trading only during/post the examined period.
- Average including all observations: 3.49%
- Average excluding best and worst observations: 1.17%
- Median: -0.35%
- Average performance of all three averages: 1.44%
The S-DH&L eREITs managed to shift into positive territory during the second examined period of rising rates/yields. Much of this improvement is attributed to names that hadn't been trading during the first period: MYCC (with 43.96% positive return) and GLPI (15.91%). Without these two names,0 the average performance of the sub-group would remain in the red (-1.8%).
Half of the observations were positive, and three names posted double-digit positive total returns (MYCC, GLPI and CMCT with 19.62%); only RWR posted a double-digit negative total return.
Unlike the first period, this time around the six S-DH&L eREITs with the smaller market caps outperformed the six largest market caps (those with a >$3 billion market cap) by ~7% (8.6% for the former versus -1.62% for the latter).
Chart 5 and 6: S-DH&L eREITs, 7/8/2016-12/15/2016
Chart 5: S-DH&L eREITs with market cap >$3bn
Chart 6: S-DH&L eREITs with market cap <$3bn
- Average including all observations: 8.96%
- Average excluding best and worst observations: 7.37%
- Median: 4.54%
- Average performance of all three averages: 6.96%
The improvement continues and 64.3% of the 14 observations ended up with positive returns. Consequently, all averages were in the green although the median (4.54%) was about 1/2 of what the regular/normal average was (8.96%). The reason for this abnormality is that we had two smaller-cap names significantly outperforming the sub-group: JCAP (48.64%) and RMR (37.95%). On the other hand, even without these two names, the average return would remain within positive territory.
With its -11.6% negative return, GLPI was the clear underperformer during the third examined period of rising rates/yields.
Just like the second period, the eight smaller market-cap S-DH&L eREITs managed to outperform the six larger S-DH&L eREITs. Nonetheless, the third period saw the difference between the two groups growing to a stunning 13.33%! (The smaller S-DH&L eREITs' average total return was 14.68% versus the six larger S-DH&L eREITs' average total return of just 1.35%)
S-DH&L eREITs - Main Results and Findings
There are a few immediate results that catch the eye regarding S-DH&L eREITs' performance during periods of increasing rates/yields:
- In spite of ending up with an anemic performance overall, the S-DH&L eREITs did show some sparks during periods of rising rates/yields and surely maintain the improvement that we've been witnessing among the specialized eREITs. With two periods, as well as the overall performance, ending up with the "average of all averages" in the green, the S-DH&L eREITs have definitely shown both resilience (to rising rates/yields) as well as ability to outperform (the VNQ and IYR benchmarks).
- Excluding JCAP and RMR that were trading only during the third examined period, we have two names that outperformed: MYCC (operating during the last two periods) with an average 27.76% total return and CMCT (operating during all three periods) with an average 11.28% total return.
- Being an ETF, it's no wonder that RWR performance was negative throughout all the three periods. Having said that, it's worthwhile noticing that RWR performed better than the benchmarks VNQ and IYR through each of the examined periods. On the other hand, KBWY, another real-estate related ETF, performed better overall but fluctuated more than RWR (compared to the benchmarks).
- Excluding the single-period operating names (JCAP and RMR) as well as the two ETFs (RWR and KBWY), there were two names that posted negative returns through each and every period of rising rates/yields - SLD and BPY. On the other side of the spectrum, only LAMR posted a positive return through each and every period out of the three examined periods. MYCC did so too, but only through the last two periods.
- It's worthwhile noticing that MYCC's outperformance continued further beyond the third examined period: This is mostly a result of the company apparently considering putting itself for sale. Therefore, I wouldn't automatically say that MYCC is the "go-to guy" here. One should always be minded to pay close attention to changes in the landscape. I wouldn't rule out that part of MYCC outperformance is being attributed to its activity being positively associated with the business and affection of the new president:
Unlike most of the previous parts, the bottom line is not so clear:
- Half of the S-DH&L eREITs are indeed special in the sense that they managed to post positive returns, on average, during periods of rising rates/yields. Almost half of the single observations were positive, and a bit over half the sub-group overall averages were positive too. That proves that when it comes to the S-DH&L eREIT sub-group, stock picking is the name of the game.
- JCAP and RMR shined the most, but they did so over only one period. Names that shined through at least two out of the three examined periods of rising rates/yields were CMCT, CMCT and LAMR over all three periods while MYCC did so over the last two periods. MYCC and LAMR were the only names (trading through at least two periods) to present a clean sheet filled with only positive return observations.
- Excluding the two diversified ETFS (RWR and KBWY), SLD and BPY were the only two names (trading through at least two periods) to present an all-red sheet, i.e. all observations ended up with negative returns.
- In two out of the three examined periods, the smaller-caps outperformed the larger caps. Nonetheless, we've seen here (the gap between the outperforming group to the underperforming group) quite a fluctuation. The magnitude of the three gaps, in absolute terms (6%, 7%, 13%), only strengthen the above-mentioned conclusion that when it comes to the S-DH&L eREITs, a successful stock-picking is key.
- There is no doubt that the diversification and/or unique features of the S-DH&L eREITs enable these names to better withstand periods of rising rates/yields than most other types of eREITs. On the other hand, just like the case was with the S-GR&I eREITs, the statistical significance isn't strong enough to point out at decisive direction. Therefore, I remain neutral when it comes to the S-DH&L eREIT sub-group.
This is the last piece in this 13-part series. I intend to publish an article that will summarize all the data that had been gathered through this series, but that may take a while longer to put together.
Once analyzing the data, I will be in a position to better differentiate between right ("resilient eREITs") and wrong ("under-threat eREITs") when it comes to investing in eREITs during periods of rising rates/yields.
Meanwhile, I intend to run two more pieces - with a similar methodology - to check the performance of Business Development Companies (BDCS, BDCL) as well as the A-Team during periods of rising rates/yields.
The most important, interesting pieces have yet to come, so bear with me, follow closely and stay tuned!
Disclosure: I am/we are long ARI, BXMT, LADR, NRZ, STWD.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am/we are SHORT O, NNN, HR, HTA, DOC, ROIC, EQIX, VTR