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Real estate: Rebound potential as rates stabilize

Key takeaways

  • Rising interest rates weighed on the real estate sector for the second year in a row in 2023.
  • Although the higher cost of borrowing was a headwind, many segments of real estate investment trusts (REITs) continued to show strong fundamentals and supply-demand dynamics.
  • 2024 could be a calmer year if interest rates level off and the pace of commercial real estate transactions normalizes.
  • Fidelity real estate portfolio managers Steve Buller and Sam Wald have found particular opportunity recently among shopping-center REITs. Data centers, senior housing, and manufactured housing have been other recent areas of interest.

While the rapid pace of interest-rate hikes over the past 2 years has impacted all sectors, it may have been felt most acutely in the real estate sector. Higher interest rates have meant a higher cost of borrowing for real estate investment trusts (REITs), which has created performance headwinds for 2 straight years.

But with the Fed signaling a potential pause on rate hikes, the time for a recovery in REITs may finally be near. And if investors look beyond negative headlines on interest rates and empty office buildings, there are actually plenty of opportunities with strong fundamentals to be found.

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2023: A sideways year

For the second consecutive year, rising borrowing costs were the most significant factor impacting REITs in 2023. The overall volume of purchases and sales remained low due to high interest rates and scarce capital. Negative headlines about empty downtown office spaces—stemming from the shift to remote work—may also have impacted investor sentiment. Altogether, these drivers contributed to a sideways performance year.

Chart shows year-to-date price performance of the real estate sector, compared with that of the S&P 500. As of December 8, 2023, the real estate sector had gained 1.99%, compared with the 19.92% gain for the S&P.
Past performance is no guarantee of future results. Real estate sector performance is represented by the S&P Real Estate Select Sector Index. Data as of December 8, 2023. Source: S&P Dow Jones Indices, a division of S&P Global.

Yet despite these challenges, many REITs continued to show strong fundamentals, driven by increased rental income. Commercial real estate supply-and-demand dynamics remained generally favorable in 2023. Moreover, in most parts of the real estate market, REITs’ balance sheets remained well positioned to weather the current market environment.

2024: Awaiting normalization, and shopping for opportunities

We believe 2024 could bring calmer seas for the sector if interest rates level off and commercial real estate transaction volume gradually normalizes.

One top recent area of interest to us has been retail shopping-center REITs. Although we’ve long avoided mall REITs due to the industry’s long-term headwinds, we see shopping centers as a more compelling category.

Malls tend to be destinations for shopping for “wants,” such as clothing and luxury items, which consumers may cut back on in a pinch. But shopping centers tend to be destinations for meeting “needs,” such as buying groceries and filling prescriptions—items that consumers are likely to continue to spend on even when times become tight. With household credit quality weakening under high interest rates, budget-conscious consumers have been gravitating to shopping centers. Furthermore, changing lifestyles driven by remote and hybrid work have benefited shopping centers, as these properties are often located nearer to people’s homes.

Favorable supply-and-demand dynamics have also benefitted shopping centers—which lease their space to commercial and retail tenants. On the demand side, retailers have proved surprisingly eager to open new stores. In terms of supply, new property development has been scarce due to the lack of construction lending, limited available land, and other forces. In 2023, available retail space fell to its lowest level in at least 18 years.1 This has given property owners increased bargaining power, and allowed them to push through big increases in asking rents—benefitting their bottom lines.

We’ve favored shopping-center REITs with strong fundamentals. For example, SITE Centers ()2 owns a portfolio of high-quality shopping centers with strong occupancies and robust rental-rate growth potential. The REIT recently announced its intention to spin off its smaller, neighborhood shopping centers into a new REIT—a transaction that will leave the company with a portfolio of larger, grocery-anchored centers. Urban Edge Properties ()3 is a REIT that owns open-air shopping centers in densely populated areas of the Northeast, which have benefitted from retail tenants’ desire to locate stores close to where consumers live.

Fund top holdings4

Top-10 holdings of the Fidelity® Real Estate Investment Portfolio () as of October 31, 2023:

  • 9.9% – Prologis Inc. REIT ()
  • 7.8% – Equinix Inc. ()
  • 7.8% – Crown Castle Inc. ()
  • 5.7% – Ventas Inc. REIT ()
  • 5.3% – SBA Communications Corp. ()
  • 4.9% – Digital Realty Trust Inc. ()
  • 4.2% – Welltower Inc. ()
  • 3.6% – UDR Inc. ()
  • 3.4% – Mid-America Apartment Communities Inc. ()
  • 2.9% – NNN REIT Inc. ()

(See the most recent fund information.)

Opportunities in data centers, senior housing, and more

Elsewhere in the REITs universe, a number of subsectors have shown promising long-term growth potential.

Data centers—where cloud providers turn to meet their massive storage needs—are one such area. The rise of artificial intelligence is accelerating the demand for these interconnection sites, which benefit from restricted supply and strong pricing power. Equinix (), a dominant data center operator around the world, is a digital infrastructure provider that has illustrated this theme.

Another theme that could have legs is health care real estate—particularly senior housing, which could enjoy a potential tailwind from demographics. A rapidly aging population in the US and some other developed nations should support demand for quality assisted living and memory-care facilities. These facilities generally cater to older individuals who can afford to pay rent out-of-pocket for their rooms. Welltower () and Ventas () are senior-housing REITs that have exemplified this trend. Both operate facilities in Canada and the UK, along with the US, and both are also invested in other health care properties such as outpatient rehab centers, medical offices, and life-science research spaces.

Finally, the nationwide shortage of affordable housing has created opportunity in the lower-cost manufactured-housing market. This sector includes RV resorts and mobile-home communities, including ones aimed at retirees. These business models can offer particularly favorable economics, since the owner/operator simply owns the land under the homes, collects rent, and doesn't need to invest much. One prime beneficiary of the strong long-term demand for manufactured housing has been Equity LifeStyle Properties (),5 which owns and operates hundreds of residential communities, resorts, marinas, and campgrounds across the country.

Practicing patience

After a volatile couple of years, we’re optimistic about the potential for a calmer year in 2024. Given the strong fundamentals and compelling long-term drivers among certain REIT subsectors, we think the coming year could be constructive for patient real-estate investors.

Steve Buller
Steve Buller
Portfolio Manager

Steve Buller is a portfolio manager in the Equity division at Fidelity Investments.

In this role, Mr. Buller manages Fidelity Real Estate Investment Portfolio, Fidelity Real Estate Investment ETF, Fidelity Advisor Global Real Estate Fund, and Fidelity Flex Real Estate Fund.

Prior to assuming his current responsibilities, Mr. Buller managed Fidelity and Fidelity Advisor International Real Estate Funds and VIP Real Estate Portfolio. Previously, he worked as an analyst covering real estate investment trusts (REITs) and the environmental industry in Fidelity’s Equity group, and as a fixed income analyst at Fidelity International Limited’s (FIL) London office. Mr. Buller also served as a distressed securities analyst and as a high yield analyst in Fidelity’s High Income group. He has been in the financial industry since joining Fidelity in 1992.

Mr. Buller earned his bachelor of arts degree in finance and German literature, as well as his master of science degree in finance from the University of Wisconsin-Madison. He is also a CFA® charterholder.
Samuel Wald
Portfolio Manager

Sam Wald is a portfolio manager in the Equity division at Fidelity Investments. Fidelity Investments is a leading provider of investment management, retirement planning, portfolio guidance, brokerage, benefits outsourcing, and other financial products and services to institutions, financial intermediaries, and individuals.

In this role, Mr. Wald manages a number of real estate/REIT equity portfolios offered in various stand-alone and multi asset class vehicles, which are distributed across various distribution channels.

Prior to assuming his current position in 2004, Mr. Wald held various other positions at Fidelity Management & Research Company LLC, including that of research analyst and research associate in the Equity Research division covering real estate, REITs, and specialty and generic pharmaceuticals stocks. He has been in the financial industry since joining Fidelity in 1996.

Mr. Wald earned his bachelor of science degree in finance, magna cum laude, from Yeshiva University. He is also a CFA® charterholder and he earned the CFA institute certificate in ESG investing and has been published in The Journal of Portfolio Management.

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Before investing, consider the funds' investment objectives, risks, charges, and expenses. Contact Fidelity for a prospectus or, if available, a summary prospectus containing this information. Read it carefully. 1. Source: CBRE Group, Inc. 2. Fidelity® Real Estate Investment Portfolio (FRESX) held a 0.83% position in this stock as of October 31, 2023. 3. Fidelity® Real Estate Investment Portfolio (FRESX) held a 1.10% position in this stock as of October 31, 2023. 4. Any holdings, asset allocation, diversification breakdowns or other composition data shown are as of the date indicated and are subject to change at any time. They may not be representative of the fund's current or future investments. The Top Ten holdings do not include money market instruments or futures contracts, if any. Depository receipts are normally combined with the underlying security. Some breakdowns may be intentionally limited to a particular asset class or other subset of the fund's entire portfolio, particularly in multi-asset class funds where the attributes of the equity and fixed income portions are different. Under the asset allocation section, international (or foreign) assets may be reported differently depending on how an investment option reports its holdings. Some do not report international (or foreign) holdings here, but instead report them in a "Regional Diversification" section. Some report them in this section in addition to the equity, bond and other allocation shown. Others report international (or foreign) holding as a subset of the equity and bond allocations shown. If the allocation without the foreign component equals (or rounds to) 100%, then international (or foreign) is a subset of the equity and bond percentage shown. 5. Fidelity® Real Estate Investment Portfolio (FRESX) held a 1.01% position in this stock as of October 31, 2023.

Views expressed are as of the date indicated, based on the information available at that time, and may change based on market or other conditions. Unless otherwise noted, the opinions provided are those of the speaker or author and not necessarily those of Fidelity Investments or its affiliates. Fidelity does not assume any duty to update any of the information.

References to specific securities or investment themes are for illustrative purposes only and should not be construed as recommendations or investment advice. This information must not be relied upon in making any investment decision. Fidelity cannot be held responsible for any type of loss incurred by applying any of the information presented. These views must not be relied upon as an indication of trading intent of any Fidelity fund or Fidelity advisor. Investment decisions should be based on an individual's own goals, time horizon, and tolerance for risk. This piece may contain assumptions that are "forward-looking statements," which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.

Past performance is no guarantee of future results.

Investing involves risk, including risk of loss.

Stock markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments. Investing in stock involves risks, including the loss of principal.

Because of its narrow focus, sector investing tends to be more volatile than investments that diversify across many sectors and companies. Sector investing is also subject to the additional risks associated with its particular industry.

Changes in real estate values or economic conditions can have a positive or negative effect on issuers in the real estate industry.

A common stock REIT is a security that sells like a stock on the major exchanges and invests in real estate directly, either through properties or mortgages. A REIT is required to invest at least 75% of total assets in real estate and to distribute 90% of its taxable income to investors.

Stock markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments. Investing in stock involves risks, including the loss of principal.

Illiquidity is an inherent risk associated with investing in real estate and REITs. There is no guarantee that the issuer of a REIT will maintain the secondary market for its shares, and redemptions may be at a price that is more or less than the original price paid. Changes in real estate values or economic downturns can have a significant negative effect on issuers in the real estate industry.

The S&P 500® Index is a market capitalization-weighted index of 500 common stocks chosen for market size, liquidity, and industry group representation to represent US equity performance. The S&P Real Estate Select Sector index comprises those companies included in the S&P 500 that are classified as members of the real estate sector, with capping applied to ensure diversification among companies within the index.

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