Publications

- February 1, 2018: Vol. 5, Number 2

The outlook for public REITs: What sectors will score during 2018 in a rising interest-rate environment?

by David Auerbach

Investors cannot be blamed for having misgivings about the value REIT shares might bring to their portfolios heading into 2018 — particularly with so much chatter about an imminent correction in real estate prices — given REIT stocks underperformed the Dow and the S&P 500 by 23 percent and 17 percent, respectively, during 2017. Let’s look at the different REIT sectors to form some overarching opinions.

Mall and retail REITs: Let’s consider the mantra, high quality trumps low quality. Check out what happened to CBL & Associates Properties in 2017, as the stock sold off and analysts downgraded the company after management cut the dividends it paid. On the other hand, examine the stories at both Macerich Co. and Taubman Centers, which are being pursued by activist shareholders pushing for changes. Regardless of the quality spectrum, these companies are facing potential issues in their mall portfolios. Outlet malls will always have some form of demand from shoppers, so a company such as Simon Property Group might benefit from a downturn in the economy that could prompt shoppers to change their habits and focus on low-cost retailers. Open a newspaper or magazine, and you will find that stories calling for mall and shopping center renovations are legion, and the drumbeat for more entertainment, dining and lifestyle tenants is loud because they are not as susceptible to online retailers. These companies are continuously innovating and updating their retail space and concepts to continue attracting shoppers for the long haul.

Apartment REITs: The story remains the same as the debate focuses on coastal versus non-coastal markets. Examine the cost of rent in New York City and San Francisco compared with Atlanta and Dallas. What happens as new supply continues to come online? Apartment REITs have their hands full trying to manage the revenue side of the equation while spending on capital improvements to spruce up their properties. What happens to millennials who are graduating, getting married and moving away from their parents? What about the group of four young people who share an apartment? One story to keep an eye on is Amazon.com Inc.’s search for a second U.S. headquarters, as the city that proffers the winning bid will likely experience a huge increase in housing demand. In Dallas, the corporate relocations that we have seen over the past couple of years have led to significant increases in rent costs.

Industrial REITs: This will be one of the most watched sectors of 2018. Industrial warehouses continue to be in hot demand, as online retailers focus on last-mile delivery options. As more companies move their products online, the need for industrial warehouse space proliferates. This particular property type will dominate the headlines in the coming year.

Data center REITs: After the Digital Realty Trust/Dupont Fabros Technology merger closed in 2017, investors started asking who would be next. More mergers might be on the horizon in 2018 as more companies take their operations to the cloud. Even though this has been one of the hottest REIT sectors over the past few years, many of these companies still do not show up on institutional investors’ radars. Will this change in 2018? What catalyst is necessary for the biggest investors to embrace these companies? Look for more press releases from the data center REITs as they announce strategic relationships, increased capacity and new development proposals, as we continue moving toward an all-online world.

Cell tower REITs: What “G” are we using now? Is it 3G, 4G, 5G or 6G? As phone networks continue to evolve and roll out next-generation technology, cell tower REITs will benefit based on new capacity and users. The real story to watch is the underdeveloped countries that are just now getting access to 3G wireless services. Pay attention to what American Tower Corp. does in Africa and India, as an example, and what kind of cultural and economic impact occurs when new towers are built. If some of these countries are on the cellular spectrum now where the United States was in 1999, one can imagine why the investment opportunities are getting cell tower REITs excited.

Self-storage REITs: Let’s face it, people hoard stuff. Our homes only have so much space, and there is a self-storage property right down the street. Even though Public Storage is the biggest player in the industry, many other players are trying to take a bite from the apple. Self-storage properties now come in all shapes and sizes, depending on location. Companies such as Jernigan Capital and CubeSmart are financing new properties across the country and working with partners to fund development opportunities. One can be assured there will always be demand for self-storage REITs in some form.

Office REITs: Can WeWork Cos. take some of the steam out of the office REIT sector? What about the decline of suburban office campuses, which are being renovated into new uses? Office REITs will continue to operate below the radar as investors focus on markets such as New York City and San Francisco, versus trying to fill office space in markets such as Atlanta, Dallas, Houston and Orlando. Speaking of Houston, how will the oil and gas industry influence office demand in the future? What will happen to the San Francisco office market if there is another tech slowdown?

Healthcare REITs: The sad truth is that everyone is getting older. Most likely, no other sector will make money off every single American in some capacity like healthcare REITs. It does not matter if it is a medical office building, physical therapy venue, surgery center or assisted-living facility, they all fall under the healthcare rubric, and healthcare REITs have positioned their portfolios to benefit. Stories to watch will be Welltower’s development at East 56th Street and Lexington Avenue in New York City, as well as the ongoing rent reimbursement battle resulting from Medicare/Medicaid cuts.

Other items: REIT investors should keep their eyes on REIT IPOs that will launch this year. In addition, one should keep a close eye on the Federal Reserve and potential interest-rate increases, as REIT performance is directly tied to interest rate movement. Also, investors would do well to monitor national employment figures and various economic reports, as they have a direct impact on REIT operations. Finally, be keen to the political scene in Washington, as changes in policy could have an impact on REIT performance.

With some luck, investors will be enjoying the ride as they strive to collect high dividends.

 

David Auerbach is an institutional trader and registered principal with Esposito Securities LLC. This author’s market commentary may not be construed as representative of Esposito Securities LLC.

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