At a time when technology stocks such as Apple, Google, Amazon and Snapchat appear to dominate stock market mindshare, it can be easy to overlook other sectors when considering where to invest. REITs, or Real Estate Investment Trusts, are a prime example of potential opportunity for investors.
A REIT is a trust company that invests in and manages income-producing real estate. The REIT market, once considered a more niche investment option, has seen extraordinary growth over the past 25 years, growing from $1.5 billion in market equity in 1971 to over $1 trillion today, as noted by Brad Thomas in his REIT investing column for Forbes.
This growth is easier to account for when considering the benefits that REITs bring to an investment portfolio. These advantages include broad diversification, strong dividends and historically low correlation to other assets such as other stocks and bonds (meaning reduced volatility). Compared to stocks, REITs are considerably more stable, protected as they are from market conditions by long-term leases and deeply diversified portfolios.
REITs also offer investors the option to curate their involvement by sector; healthcare, industrials, retail and single-family rental REITs are a few prominent examples.
Headwinds and Tailwinds in REIT Sectors
Diverse as they are, each REIT sector presents unique opportunities and headwinds. Among the most scrutinized, as you might expect, are retail and healthcare REITs, where the underlying assets are currently facing disruptive periods of transition.
Retail REITs are overshadowed by the same concerns that have plagued the retail sector in recent years – including high volume of store closures, bankruptcies and increased competition from online retailers. Mizuho senior REIT analyst Haendel St. Juste (whose coverage includes retail, triple net, single family rental and homebuilders), points to “negative retail psychology and lack of near-term asset pricing discovery” as likely to keep some investors on the sidelines, “though the retail REITs appear set up well for a relief rally.”
Healthcare and hospital REITs, linked to ongoing healthcare reform, face prolonged ambiguity. Richard Anderson, senior REIT analyst (whose coverage includes healthcare, office and industrial), advises caution for investors, noting that “the still uncertain political climate, and a changing interest rate environment, may make this sector a moving target for now…resolution of the political unknowns is a prerequisite for making a case on the overall sector.”
More positively, a surge in demand has proven a tailwind for industrial REITs. In fact, “development of industrial space in the U.S. is at a 10-year high,” according to a recent article in The Wall Street Journal, while “rents are [also] at record highs, and vacancies are at a 17-year low.” Interestingly, a major tailwind for industrial REITs is perhaps the most prominent headwind for retail – online commerce. “Many of these REITs lease to logistics companies like FedEx and Amazon and the demand for these e-commerce hubs will likely continue as a result of increased on-line shopping,” noted Thomas in Forbes.
Single family rental REITs, a relatively new category, are experiencing a multitude of tailwinds, according to St. Juste, including “high demand, potentially rising interest rates that could stretch affordability and force more people into rentership, a negative psychology towards home ownership in this country stemming from the housing crash and [changing] homeowner demographics.” He also called attention to the high margins for investors in this sector, which are “comparable margins to apartments, maybe higher. The average person stays three to four years in a rental home and two years in an apartment.”
How to Pick the Right REIT
When evaluating individual REITs, investors should examine anticipated growth, earnings growth and momentum, the quality and effectiveness of the management team, the value of the underlying assets and exposure to market events (such as the passage of key legislation).
REITs currently viewed favorably by the Mizuho analyst team include Colony Starwood (SFR), Essex Property Trust (ESS), and Alexandria Real Estate (ARE).
SFR, a single-family rental REIT, which offers investors both a significant growth story (St. Juste estimates 13-14% earnings growth) and notable value, trading at a discount to its larger peers.
ESS, a West Coast-focused multifamily REIT, has a number of attractive characteristics, according to Anderson. Their management team is widely considered top-notch, their recent deceleration of internal growth (tied to elevated levels of supply) is expected to begin reversing as early as later this year and the targeted nature of their portfolio, though a longer-term risk, is expected to generate premium growth acceleration over the next 12 months.
ARE, another Anderson top pick, is “a unique Class A office REIT that owns life science real estate which typically involves a combination of clean-air laboratory and office space, with most tenants in the biopharma (drug research) industry. ARE produces both near-term growth from strong same store performance, with the prospects of future NAV accretion tied to an appropriately sized development pipeline. Its portfolio is focused on the major hubs of pharmaceutical activity including Cambridge (MA), San Francisco, San Diego and New York City.”
Diverse, stable and growing, REITs are fast evolving into a foundational investment for portfolios. This traditionally underestimated sector will soon take its rightful place as one of the most attractive investment options - and the time is now for investors at every level to identify the REIT opportunities for them.
Simon Hylson-Smith is a former financial industry editor and currently CEO of Paragon.