This article is republished with permission from REITCafe.

At the recent REIT World Conference in Las Vegas, industry experts noted that real estate market fundamentals are strong and that real estate investment trust (REIT) earnings are solid, yet REIT performance this year has been flat, and higher interest rates are on the horizon.

The experts are looking forward to 2016, when REITs will be separated from financial services and elevated into a new Global Industry Classification Standard (GICS) sector. Favorite REIT sectors include industries that have been beaten up, like health care and lodging. Nontraditional sectors that can be bought at a higher cap rate than core sectors like apartments also are attractive. Self-storage and apartments are also attractive because of favorable demographic trends.

TREPP-i Survey Loan Spreads (50–59% LTV)* 
This Week  Previous Week  Previous Month  End 2014 End 2013
Industrial 164 166 166 138.5 170
Multifamily 160 164  162 139.8 166.7
Office 171 173 174 148 175
Retail 164 166 165 139.8 175
Average Spread 164.75 167.25 166.75 141.5 171.7
10-year Treasury Yield** 2.26 2.27 2.03 2.17 3.04

Current REIT valuations largely reflect interest rate uncertainty. But Brad Case, senior vice president of research and industry Information for the National Association of Real Estate Investment Trusts, said he does not believe that higher interest rates necessarily mean worsening REIT performance. His research shows that REIT returns were positive during 12 periods in which interest rates have risen.

Capital flowing into the U.S. market is driving up property prices. Most notably, investors from around the world are looking to safe, iconic U.S. assets and are willing to buy at low cap rates, said Sherry Rexroad, managing director and chief investment officer of the Americas for Blackrock. Rich valuations are making expansion through acquisitions difficult for REITs. Many REITs are taking advantage of the situation by selling assets and using proceeds for new development, share buybacks, and buying other REITs.

Many REITs are trading at a discount to net asset value, but Mike Kirby, chairman and director of research for Green Street Advisors, said that REITs are fairly valued, but real property is tilting more toward an overvaluation situation. He notes that buyers of public REITs are different than investors in private assets, and private equity firms that are significant investors in private assets can justify paying higher prices for real assets and still achieve required returns.

* 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 11/20/2015.