This article is republished with permission from REITCafe.
The performance of real estate investment trusts (REITs) outpaced the broader markets during March and ended the first quarter with a 5.86 percent total return. The U.S. economy appears to be maintaining its growth trajectory in spite of global economic uncertainty and weakness in oil markets. March employment growth stayed strong, contributing to a quarterly gain of 628,000 jobs, which is helping fuel demand for commercial real estate. At the same time, new construction has stayed in check. Overbuilding is largely not a concern, except for some property types in selected markets.
The still-low interest rate environment caused the REIT sector, with its high dividend yields, to strengthen during March. The Federal Reserve’s first rate increase in December unsettled markets and caused them to pull back, but Fed Chair Janet Yellen’s repeated message about moving “cautiously” and the lack of further rate increases have reduced market concerns.
For REITs, strong real estate market fundamentals are boosting profitability even as rich asset pricing has made acquisitions more challenging. In fact, a number of REITs announced during their quarterly earnings calls that they plan to be net sellers of assets in the current environment. Because REITs continue to trade at a discount to net asset value, some are using proceeds from sales to buy back shares or invest in other REITs.
| TREPP-i Survey Loan Spreads (50–59% LTV)* |
| This Week | Previous Week | Previous Month | End 2015 | End 2014 | |
| Industrial | 166 | 169 | 178 | 163 | 138.5 |
| Multifamily | 165 | 168 | 185 | 168 | 139.8 |
| Office | 175 | 178 | 164 | 168 | 148 |
| Retail | 165 | 169 | 177 | 168 | 139.8 |
| Average Spread | 167.75 | 171 | 178.75 | 166.75 | 141.5 |
| 10-year Treasury Yield** | 1.79 | 1.89 | 1.73 | 2.27 | 2.17 |
Among the various REIT sectors, freestanding retail REITs have offered the best returns this year. With bond-like yields that offer safety in an uncertain environment and tenants that are more resilient than traditional retailers in the face of e-commerce, freestanding retail REITS posted an 18.69 percent first-quarter return. Also posting exceptionally strong returns this year are data center REITs, whose 14.29 percent return has been fueled by the expansion of cloud computing.
Timber REITs made a strong recovery in March as greater clarity on interest-rate movement fueled the homebuilding industry. The sector gained 19.60 percent during March and is now up 5.33 percent for the quarter. Despite a gain of 13.30 percent during March, single-family home REITs continue to struggle and are down 1.03 percent for the year.
At the crux of why shares are trading at a discount to net asset value is concern about whether REITs are plateauing or overshooting and whether they will be able to maintain growth. Certain markets and product types, such as hotels in New York City and office space in tech markets like San Francisco, are most susceptible to these concerns.
Initial public offering (IPO) activity has been minimal this year, but some firms, grandfathered in when Congress passed a bill in December that essentially bans REIT spinoffs, are moving ahead with their plans.
Hilton Worldwide is spinning off the majority of its real estate business into a REIT that will include about 70 properties and 35,000 rooms. MGM Growth Properties (MGP) filed for an estimated $1 billion IPO. MGP will be spun off from MGM Resorts International and will own Mandalay Bay, Mirage, New York–New York, Monte Carlo, Luxor, Excalibur, and the Park in Las Vegas, as well as properties in Detroit and Mississippi—a total of 24,466 hotel rooms, about 2.5 million square feet of convention space, retail space, restaurants, and entertainment venues. Macy’s, which rejected the idea of a REIT spinoff in 2015, recently added REIT veteran William Lenehan to its board as it continues to face pressure for a real estate spinoff.
Strong March performance sets the pace for a year in which equity REITs and other listed real estate companies will be reclassified into a new Global Industry Classification Standard (GICS) sector, and during which foreign investors will be allowed to increase their REIT ownership without triggering Foreign Investment in Real Property Tax Act (FIRPTA) taxes.
* 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 4/1/2016.
