REITs keep getting spanked, but here are some bright spots

Think baby boomer categories that tap health care, downsizing.

  • By Andrea Riquier,
  • MarketWatch
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  • Real Estate
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The advantage of exposure to real estate as a more concrete option among financial assets has been hard to glean from the dismal performance of real estate investment trusts over the past few years.

But some investors say there are bright spots emerging among REITs.

"It's still a pretty good time to buy some REITs," said David Copp, manager of the TIAA-CREF Real Estate Securities Fund (TCREX). "We're not where we were 10 years ago. We're now at a point in the cycle where investors need to be much more selective."

First, a reminder of why investors have shied away, taking REIT investments, including the SPDR Real Estate Select Sector ETF (XLRE) , down more than 5% for the year to date.

REITs didn't benefit from the Trump administration tax cuts as much as other industries did. Most REITs generally don't owe taxes because they pass on most of their earnings to investors. It's also quite late in the economic cycle, but more critically, in the real estate cycle. That means occupancy rates are already high and rental rate growth is starting to slow.

But the more worrisome macro trend is rising interest rates. Many investors choose REITs as income-producing assets. That means their value will erode as inflation and rates rise. And others worry that rising rates make property acquisition and ownership more expensive for REITs, which could throttle their growth.

"It's true that rising interest rates are a headwind," Michael Gorman, a BTIG analyst, told MarketWatch. But other than in specific "rate shock" situations, like the 2013 "taper tantrum," when then-Fed chair Ben Bernanke spooked markets and sparked a bond selloff, "you do see the ability for REITS to keep up and perform," he said.

Notably, industry group Nareit says higher rates are just not a big issue, at least not now: REIT leverage is at the lowest levels ever recorded, the group says, and about 81% of outstanding debt held by the trusts is fixed rate, with a weighted average term to maturity of 6.3 years.

Gorman and Copp offered some ideas on which select REIT categories make good buys at this point.

Health care: BTIG prefers medical office REITs. As Gorman puts it, "There's a ton of institutional demand. It benefits from all the macro trends, it benefits from the aging population and it's not as regulated [as, say, skilled-nursing facilities are]." BTIG has buy ratings on Healthcare Trust of America, Inc. (HTA) and Physicians Realty Trust (DOC).

Bargain-hunting for the right REITs

Despite the bargain prices, it may pay to be choosy.

Hotels: BTIG also thinks hotels are poised to do well. That's a sector that "typically outperform(s) during periods of rising GDP and interest rates," the group wrote in a recent research note. Hotels and industrials both reported the strongest new guidance during Q1 earnings season. BTIG has buy ratings on Host Hotels & Resorts, Inc. (HST) and on Pebblebrook Hotel Trust (PEB).

Manufactured-home communities: Copp's fund holds shares of the only two players in the space. Sun Communities, Inc. (SUI) and Equity LifeStyle Properties, Inc. (ELS). He said both offer a professionally-managed option for the lower end of the housing market — the segment that's chronically squeezed. As Copp puts it, the two companies "are better capitalized and a cleaner and nicer experience for the tenants than RV parks."

Those tenants "tend to be fairly sticky," Copp said. "It's difficult and costly for tenants to move." And the manufactured-home communities can command annual rental growth of about 5% and tend to weather downturns better than apartments do.

The communities are also set to benefit from the aging population. Retiring baby boomers may choose to keep their homes but live as "snowbirds" in manufactured homes, or they simply downsize altogether.

Across all REITs, Gorman cautioned, don't expect gangbusters growth in the short term.

"Generally we're looking for a flattish year, 0-4% total return," he said. "We do expect that to pick up again in 2019 as you start to see a more measured view toward interest rates, more investment spending and a pickup in inflation that can drive through to the rental revenue line."

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