As REITs rebound, these sectors stand out

Data centers, cellphone towers and ordinary housing are attracting investors.

  • By Dan Weil,
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Real-estate investment trusts are rebounding after several years of sluggishness.

The S&P U.S. REIT Index returned 8.3% for the three months ended Aug. 31, outperforming the S&P 500 (.SPX), which returned 7.8% over the same period, notes Amanda Agati, co-chief investment strategist at PNC Financial Services Group.

The start of 2018 didn’t look so promising for REIT investors. In the first two months, REITs were driven lower by fears of rapid interest-rate increases by the Federal Reserve. Rising rates hurt REITs because the trusts compete with bonds partly on the basis of yields, and because higher rates raise borrowing costs for REITs, which often take on substantial debt to buy their properties.

More recently, however, worries about rising rates have faded. “Now the concern is about an economic slowdown in the second half,” which suggests a more benign interest-rate environment for REIT investors, says Steven Brown, senior portfolio manager at American Century Investments.

Better fundamentals

“Today we feel good about real-estate fundamentals,” says Tom Bohjalian, a portfolio manager at Cohen & Steers, which specializes in real-estate investing. Indeed, while expectations for higher interest rates have eased, he says, the economy remains strong enough to continue fueling demand in housing and a number of other real-estate sectors.

“While supply is higher than usual for this stage of the real-estate cycle, we think it will diminish in late 2018 and 2019,” he says. “So REITs will have pricing power to raise rents on high levels of occupancy.”

Some experts see opportunities in office REITs. Mr. Brown, for one, likes Boston Properties Inc. (BXP), whose shares, he says, are trading at a discount despite a portfolio concentrated in Washington, D.C., New York, Boston and San Francisco. Demand for top-quality office space remains strong in those cities, Mr. Brown says. While there is concern about weakness in financial jobs in those markets, he says, “media, telecom and technology have good job growth and tenant demand.”

Other sectors in commercial real estate that industry insiders particularly like include data centers and cellphone towers. Data-center and cellphone-tower REITs are benefiting from the explosion in data usage, including e-commerce and video on demand. The growth of cloud computing plays a big role as well for data centers. “The need and desire for high-performance networks is driving demand for data-center space and more cellphone towers,” Mr. Bohjalian says.

One data-center REIT experts recommend is Equinix Inc. (EQIX), the world’s largest retail data-center provider by revenue, according to Morningstar. “The company has caught the tide of cloud computing at the right time since birth,” Morningstar analyst Neil Macker writes in a report. “Key to its success is the business ecosystem joined by both magnetic cloud platforms, such as Amazon and Google, which attract other tenants to Equinix, as well as telecommunication carriers that offer connectivity services on site.”

The housing play

As for housing REITs, Mr. Bohjalian says the number of families in need of homes is expected to grow in the next three to five years, and demand will ultimately exceed supply. That bodes well, he says, for REITs that specialize in apartments, manufactured housing and single-family rentals. Experts also agree that the rising price of purchasing a single-family home will keep people in apartments longer, giving owners the ability to raise rents.

Mr. Brown recommends American Homes 4 Rent (AMH). This REIT’s shares currently trade at roughly a 10% discount to net asset value, he says, and the value of its portfolio is rising. “They can raise rents higher than inflation,” he says, thanks to rising demand from residents who can’t afford to buy a home.

Going to the mall

Mr. Brown even likes some REITs in the retail sector. Store closings are now running 50% to 60% below 2017 levels, he says. “That’s having a positive impact on the leasing environment.” And many retailers have begun to respond more effectively to Amazon.com Inc. (AMZN) and other e-commerce companies by beefing up their own e-commerce efforts and the portfolios of their bricks-and-mortar stores, he says.

Some Class A malls and shopping-center REITs posted respectable earnings for the first and second quarters, beating expectations, he says.

Mr. Brown likes the largest Class A mall owner, Simon Property Group Inc. (SPG). It has a “very good redevelopment pipeline and a very good balance sheet,” he says. He also likes the shopping-center REIT Regency Centers Corp. (REG), which he says has maintained strong occupancy rates, helped by the fact that it has modest exposure to troubled retailers, such as Toys R Us Inc., Brookstone, Sears and Kmart.

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