This article is republished with permission from REITCafe.
Strong returns and limited risk have been key factors in the success of freestanding retail real estate investment trusts (REITs) during 2016. The relative safety of these REITs within the broader sector and stability of their dividends during a period of economic uncertainty have made the sector stand out. Year-to-date through July 6, 2016, the sector posted a 37.29 percent total return. But as these REITs reach 52-week highs, is it time to buy, hold, or sell?
Interest rates play a key role in the sector’s outlook. Very low interest rates make the sector’s 3.73 percent dividend yield attractive, and allow REITs to borrow inexpensively to fund expansion. To boot, a near-term interest rate increase is less likely due to Brexit and weak May job numbers. Recently released minutes from the Federal Reserve’s June meeting indicated that policy makers are unlikely to raise rates until the fallout from Brexit can be better gauged. Thus, it appears that low interest rates will persist longer than many investors expected, which is good news for these REITs.
| TREPP-i Survey Loan Spreads (50–59% LTV)* |
| This Week | Previous Week | Previous Month | End 2015 | End 2014 | |
| Industrial | 175 | 173 | 168 | 163 | 138.5 |
| Multifamily | 172 | 172 | 168 | 168 | 139.8 |
| Office | 187 | 182 | 179 | 168 | 148 |
| Retail | 177 | 173 | 168 | 168 | 139.8 |
| Average Spread | 177.75 | 175.00 | 170.75 | 166.75 | 141.5 |
| 10-year Treasury Yield** | 1.37 | 1.44 | 1.58 | 2.27 | 2.17 |
Properties owned by freestanding retail REITs are generally less vulnerable to e-commerce than other retail sectors and consequently outperform relative to shopping center and regional mall REITs. The freestanding buildings generally owned by these REITs are mostly occupied by nationally known nondiscretionary and service businesses that are less vulnerable to online retail, including drugstores, convenience stores, restaurants, health and fitness studios, and dollar stores. Some REITs are diversifying beyond retail to other property sectors like office, industrial, and health care and lease to tenants on a triple-net (NNN) basis. Income growth and rent growth are guaranteed through long-term NNN leases.
The three largest freestanding retail REITs will release second-quarter earnings in late July or early August. Given currently healthy real estate market fundamentals, no surprises are expected. Realty Income Corporation, National Retail Properties, and Spirit Realty Capital will release second-quarter earnings on July 27, August 2, and August 3, respectively.
If and when interest rates do rise, the long-term bondlike leases that currently make the sector attractive could have the opposite effect, and the sector’s defined revenue streams over long lease terms will become less appealing. So whether freestanding retail REITs are a buy, hold, or sell is contingent on the outlook for interest rates and the economy as a whole.
* TREPP-i Survey Loan Spreads levels are based on a survey of balance sheet lenders. For more information, visit Trepp.com.
** - 10 yr. Treasury Yield as of 7/8/2016.
