REITs Outperforming Broader Markets in 2016

This article is republished with permission from REITCafe.

Real estate investment trusts (REITs) performed well in June, even as events rattled broader stock markets. The total FTSE NAREIT All REIT Index return gained 6.68 percent in June, bringing the total return for the first half of 2016 to 13.65 percent. Freestanding retail, single-family home, data center, manufactured home, and infrastructure REITs posted double-digit gains during the month while timber lagged.

Several events during June had positive implications for the REIT sector. Most notably, the U.K. vote to exit the European Union shook financial markets worldwide. REITs, viewed as a safe haven by investors, stood up well as broader U.S. markets tumbled. The probability that the Federal Reserve will raise interest rates in July or September has been lowered significantly as a result of heightened global economic uncertainty resulting from the vote. REITs will benefit from low interest rates because of their attractive yield and because they rely on borrowing for growth. Uncertainty created by the vote also could trigger additional foreign investment in U.S. real estate and REITs.

The U.S. economy is healthy, with low unemployment and rising wages. Job growth slowed in May, but existing home sales reached their fastest pace in almost two years. New home construction edged downward during April, but an increase in building-permit activity indicated that developers are aiming to make a dent in the low supply. Low energy costs have also boosted disposable income. Consumer confidence climbed in June, following two months of decline.

The opening of the third set of locks on the Panama Canal, at a cost of the $5.4 billion, was largely overlooked amid the Brexit turmoil. The new locks opened June 26, increasing the size of ships that can move through the canal to 14,000 containers from the previous maximum of 5,000. The expansion will have more of an impact on railroads that transport goods across the country than on industrial REITs, but it will change how and where goods are transported.

Merger and acquisition activity was ongoing during June. Early in the month, Colony Capital announced plans to merge with NorthStar Asset Management Group and NorthStar Realty Finance to create a new company, Colony NorthStar, with $58 billion in assets. In addition, the Weisman Group made a $1.48 billion unsolicited offer to acquire Ashford Hospitality Prime (AHP).

Underlying real estate fundamentals are healthy, and REITs made strong gains during the first half of 2016. By the time August ends, both the S&P Dow Jones and MSCI Indices will reclassify equity REITs and other real estate companies from financial stocks into a new, 11th real estate sector. REITs will gain new visibility and could become less volatile because they will no longer be a small part of the financial sector. Many actively managed large-cap core mutual funds currently underweigh REITs. Will funds push REIT values up further by buying shares ahead of the sector change, or will they wait until REIT pricing is more favorable?

* 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 7/1/2016.