"Brexit Firpta Gics!" (Translation: REITs Should Outperform)

Richard Anderson and Haendel St. Juste
Richard Anderson and Haendel St. Juste
June 28, 2016



A series of non-fundamental factors appear to be net near-term supportive for US REITs, including "Brexit" (lower interest rates), FIRPTA (more foreign demand for US real estate and REITs), and the 11th GICS sector (greater generalist attention in REITs). We see varying degrees of impact from these external forces on REIT stock performance individually, but collectively a positive set of circumstances that should also resonate well with relative sound supply/demand fundamentals. As a result, we expect US REITs to continue to outperform broader markets in 2H16. We think the search for REIT alpha within this industry observation starts with our 12 Buy rated stocks listed to the right, but we expect stock-specific debates to be the focal point during the second half of the year given macro angst and a winnowing list of safe and cheap sectors.

■ Brexit: From MSUSA Chief Economist Steve Ricchiuto: "(We) see no reason to rush into equities, especially in what is likely to be a very negative political season and a period of global economic and political uncertainty, leaving us with a “Grab Yield Strategy”. The UK “yes” vote simply adds to this strategy near-term as the uncertainty and contagion concerns are an economic negative." Although REITs are both equities and yield vehicles, and we expect the latter to win out for now. We could be at or near the floor on the 10-year Treasury (1.46%) based on this separate Ricchiuto comment: "The 10-year treasury should be sold below 1.5% as this is probably a longerterm inflationary event.", but we think that is a dialogue for another day from the REIT perspective.

■ FIRPTA: As we detailed in a note recently (see it here), the PATH Act of 2015 included several modifications to the Foreign Investment in Real Property Tax Act (FIRPTA) that reduced or eliminated tax withholdings for foreigners invested in US real estate or US REITs. So far, an informal poll of US REIT managers suggests any FIRPTA impact is moving at a glacial pace at best. We think a worst case scenario is no change in demand for REITs from non-US investors. But all else being equal, we think the more likely scenario is some incremental interest in direct or indirect ownership in US commercial real estate, purely on the basis that it became less expensive with the new FIRPTA guidelines.

■ GICS #11: Finally, there is a lot of debate in the markets surrounding the incremental demand for REIT shares leading up to the REIT carve out from financials in August. We think behavioral factors like this are more likely to take time to manifest themselves in stock performance, and the implications of the new sector, in and of itself, may be hard to decipher. But taken in combination with the other two factors highlighted in this note, we think GICS 11 may be more influential than as a standalone force. We see a few baskets of potential generalist demand related to the carve out: a) large cap/ high quality REITs (given the widely benchmarked S&P 500), b) attractive cash flow multiples (since generalist may not be as in tune with NAV valuations), and c) a "buy what you know" strategy (new REIT investors may find comfort in areas that they interface with in daily life, such as malls, apartments and hotels). 

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