This article is republished with permission from REITCafe.
Real estate investment trusts (REITs) rallied during July, recovering from a weak first half of 2015. The return on the FTSE NAREIT All Equity REIT index totaled 4.99 percent, but even after the strong month, the year-to-date total return was –0.73 percent, trailing some of the broader market indices. Despite reporting mostly strong second-quarter earnings, concerns about higher interest rates weigh on the sector.
The second-quarter earnings season began in July, and many of the largest REITs reported growth from last year and/or earnings that beat analysts’ estimates. REITs announced strong performance of their underlying real estate assets and plans for future growth. While many noted that acquisitions have become more challenging because of high valuations, they are ramping up development to achieve growth.
| TREPP-i Survey Loan Spreads (50–59% LTV)* |
| This Week | Previous Week | Previous Month | End 2014 | End 2013 | |
| Industrial | 150 | 149 | 139 | 138.5 | 170 |
| Multifamily | 145 | 146 | 141 | 139.8 | 166.7 |
| Office | 160 | 158 | 145 | 148 | 175 |
| Retail | 152 | 150 | 141 | 139.8 | 175 |
| Average Spread | 151.75 | 150.75 | 141.5 | 141.5 | 171.7 |
| 10-year Treasury Yield** | 2.17 | 2.20 | 2.25 | 2.17 | 3.04 |
Buoyed by strong earnings, almost every REIT sector reported positive returns during July. Self-storage (11.54 percent) and manufactured homes (10.72 percent) performed best during July and year-to-date. Industrial REITs (8.67 percent) also posted strong total returns during July, fueled by strong earnings and a 9.5 percent monthly gain in Prologis’s stock price. Retail REITs posted gains of 7.20 percent in July, with relatively even performance among shopping centers, regional malls, and freestanding retail sectors. Positive economic and demographic trends propelled apartment REITs (6.14 percent) forward. Lodging and timber were the only sectors with negative total returns for the month.
The U.S. REIT initial public offering (IPO) market was quiet during July, as several proposed REITs postponed their IPOs. ETRE REIT, formed to own an interest in State Street’s Boston headquarters, was scheduled to go public in late July, but postponed its IPO because of poor market conditions. Also citing poor market conditions was RiverBanc Multifamily Investors, which sought to raise about $78 million. Nevertheless, Orange County, California–based Rich Uncles REIT filed with the U.S. Securities and Exchange Commission for a net lease REIT IPO of up to $1 billion.
In addition to earnings, mixed economic news on job growth and housing that kept a potential interest rate hike at bay contributed to positive REIT performance in July, even as concern about higher interest rates has negatively affected REITs through much of 2015. At the Federal Open Market Committee meeting late in the month, the Fed indicated that the first interest rate increase in almost ten years could occur in September. A small, gradual interest rate increase is unlikely to derail the U.S. economy or REIT earnings, but higher rates will affect REIT borrowing costs and could make REITs less attractive compared with other investments.
The current situation, where stock values have been pulled down in spite of strong underlying performance, could create an opportunity for investors, albeit one that is risky because of the ongoing competing influences of earnings and interest rates.
* 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 08/07/2015.
