Heard On The REITs - REITs Shrug Off Inflation

Summary

• Despite lower-than-expected GDP growth, the economy's growth is broad based and is expected to pick up in 2Q.
• Some REIT sectors that have been outperforming gave back some of their gains but are still offering compelling buying opportunities.
• Consumers continue to drive Retail REITs, and with sentiment still high, I don't see an end to that trend yet.

The MSCI US REIT (RMZ) index outperformed the S&P 500 (SPY) with a return of 0.4% compared to a loss of 1.3% for the S&P. The one-month outperformance is now almost 6% as REITs seem to be shrugging off current and potential rate hikes and instead are being driven by economic growth and inflation.

Single Family Homes seem to have given back some gains, but the average decline was primarily driven by a 6.5% drop in Reven Housing (RVEN), while Invitation Homes (INVH) and American Homes 4 Rent (AMH) were up 2% and 1.5%, respectively.

Regional Malls gave back some of their gains as well with a decline of 3.1%, and unlike Single Family Homes, the declines were broad based with CBL & Associates (CBL) declining 6.8% followed by Pennsylvania Real Estate (PEI) with a drop of 5.6%.

Timber bounced back this week with a gain of 2.4%, led by a 5.2% return from PotlatchDeltic (PCH) which was recently added to our Low Vol REIT portfolio and is currently being reviewed for a research update.

Data Centers and Manufactured Homes round out the Top 3 performing sectors this week with a 1.9% and 1.7% return, respectively. Within Data Centers, 4 out of the 5 stocks were up, with only QTS Realty (QTS) declining by 0.6%. Meanwhile, UMH Properties (UMH) led the Manufactured Homes sector with a 2.8% return and is now up 16% over the last 3-month period.

Returns as of 6/29/2018

Note: Returns are based on the average returns all REITs within each sector. Not market-weighted.

Top and Bottom Performers

Top 5

Bottom 5

REITonomics

GDP was a disappointment this week with an estimated 2% growth, which was lower than the 2.2% expected. Economists forecast that 2Q growth will be much stronger and that some of the expected growth that didn't occur in 1Q would shift to the next quarter.

New Home Sales

New home sales increased 6.7% to an annualized rate of 689,000 while April's number of units was revised down from 662,000 to 642,000. Overall, the trend is still upward in this very volatile data, which is good news. But activity is well below the 1.4M units reached before the previous recession. That number was obviously unsustainable, but the concern now is whether the trend will continue as rates rise.

Durable Goods Orders

Durable goods order declined last month by 0.6% while Core durable goods orders declined 0.3%. Durable goods are those items that typically last for at least 3 years.

Pending Home Sales

Pending home sales declined last month, which was disappointing considering the forecast was for a 1.1% increase. The result could be driven by the timing of closings – faster closings than new contracts – or a slowdown in new contracts – or a combination of the two. Generally speaking, however, a higher than expected number is positive and not only was the latest release below expectations, it was the second month in a row of declines. If consumers slow down the pace of home purchases, we are once again reevaluating the longevity of the Single Family Home REITs.

GDP

GDP came in at a disappointing 2% while economists had forecast 2.2% growth. The good news was that growth was more evenly distributed this period compared to the prior period. Contribution from personal consumption was 0.6% while private investment was 1.22%. Government spending contributed 0.22% and net exports were almost a non-factor with a contribution to GDP of -0.4%. Despite the lower-than-expected overall growth number, the economy seems to be growing steadily without any one component overwhelmingly dominating. In my opinion, that’s a good recipe for further growth.

Initial Jobless Claims

Initial claims ticked slightly upward this week, but the less volatile 4-week moving average continued to trend downward – further fuel for consumer confidence, spending, and quite possibly, wage growth and inflation.

Core PCE Price Index

The Core PCE Price Index hits its highest level in several years and finally hit the Feds target of 2%. Technically, it was 1.96%, but the story is that inflation is here, even if it's still benign. In 2016, we had several consecutive months that indicated inflation was taking hold, only to drop back down to below 1.5%. I believe this time it’s for real.

Personal Spending

Consumer sentiment is still high which usually translates into consumer spending. Personal spending was up for the third month in a row which bodes well for Retail REITs.

Michigan Consumer Sentiment

Despite a slight decline in the University of Michigan Consumer Sentiment index, it remains near all-time highs. I believe this trend will continue so long as the labor market remains strong. Wage growth should continue to firm up, which translates into at least another leg of consumer spending.

Select News Highlights

Please note these are highlights and have not been further analyzed beyond announced information.

• InnSuites Hospitality (IHT) reported a revenue decline of 13.7%.
• Searchlight Capital Partners is offering to sell 5.5M shares of Uniti Group (UNIT) at a price of $20.60 to $20.80 per share – a 1.7% to 2.7% discount to the price at which the stock was trading when it was announced. It's not good news when a major shareholder wants to get out of a stock at a discount, although you never know, it could be that Searchlight needs to have some liquidity quickly. Uniti fundamentals aren't any different than they were last week so this could be a buying opportunity for investors who missed the recent run-up.
• Investors Real Estate Trust (IRET) missed FFO estimates by $0.01 despite a revenue increase of 3.2%, which beat estimates by $260K.
• Wheeler REIT (WHLR) reduced its debt by $20M – a step in the right direction for a REIT whose stock price has been battered.
• Apollo Global Management LLC is the mystery buyer that is under contract to buy a $428M portfolio from HCP (HCP). It is buying 22 properties currently managed by Brookdale Senior Living.

Analyst Upgrades/Downgrades

Upgrades

• Suntrust and DA Davidson both upgraded Federal Realty Investment Trust (FRT) to buy.
• Franklin Street Properties (FSP) was raised to outperform from neutral by Baird. Shares were up about 2.7% on the news.
• Deutsche Bank raised its target price for Boston Properties (BXP) to $134 from $133 and raised its price target on Mack-Cali Realty (CLI) to $21 from $20. A more material price target increase was assigned to Kilroy Realty (KRC), whose target price was raised from $75 to $81.
• RBC initiated coverage on City Office REIT (CIO) with an Outperform rating and price target of $14.
• Citigroup raised Mack-Cali price target to $20 from $18.
• DA Davidson raised Piedmont Office Realty Trust (PDM) from neutral to Buy and lifted target price $3 to $23.

Downgrades

• BTIG Research downgraded Spirit Realty (SRC) to Neutral from Buy with a price target of $9.
• Wells Fargo downgraded Omega Healthcare (OHI) to market perform from Outperform. The new consensus price target is $30. Wells Fargo suggests further dividend increases unlikely.
• Deutsche Bank reduced its target price on Vornado Realty Trust (VNO) to $80 from $82.
• Evercore ISI downgraded Education Realty Trust (EDR) to In Line from Outperform and lowered its price target to $41.50 from $42. KeyBanc also downgraded EDR to Sector Weight after the Greystar acquisition.
• DA Davidson cut Rexford Industrial (REXR) to neutral from Buy and lowered its price target to $35 from $40.

Next Up:

The report on Cousins Properties (CUZ) and Sabra Healthcare (SBRA) were published on REITs, Opportunities, and Income and I expect a report on New Senior Investment (SNR) to be published shortly. This coming week I will also be publishing the portfolio summary for readers interested in how the Low Vol REIT Portfolio is performing relative to the MSCI US REIT Index and on an absolute basis. Spoiler alert, it continues to outperform.

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Disclosure: I am/we are long BXP. 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.