(Reuters) – The once-sleepy U.S. real estate sector could be poised to continue its revival into the second half of 2019 but investors are selective in their bets on property companies.
People work on a construction site to build a new apartment building in Los Angeles, California February 6, 2015. REUTERS/Lucy Nicholson
While residential and industrial Real Estate Investment Trusts (REITs) are the most popular bets, office REITs look less attractive and retail is out of favor.
The dividend-rich, slow-growth S&P 500 Real Estate index .SPLRCR has risen 18.5% so far in 2019, beating the S&P 500’s 16.99% gain. Unless the tide turns, real estate is on track for its biggest annual advance since 2014.
At several points this year and as recently as June 5, the real estate’s index’s year-to-date gains outpaced even the high-flying tech sector .SPLRCT.
Sector investors are optimistic that REITs can advance more as long as broader U.S. earnings growth stays weak and interest rates stay low.
“If the Fed policy is benign and you don’t see an acceleration of earnings, (REIT) dividend yields and a steady cash flow are pretty attractive to investors,” said Bob Zenouzi, Macquarie Investment’s chief investment officer for real estate.
He sees REIT dividend yields of 4.5% and cash flow growth of 4-5% bringing a high-single digit to low-double digit percentage return rate for REIT investors in the next 12 to 18 months.
Also citing solid REIT earnings expectations and high dividends, Gina Szymanski, portfolio manager, at AEW Capital Management, is looking for REIT returns in the high single-digit range in the next 12 months.
However, the sector’s price to net asset book value multiple is 3.8, higher than its historical average of less than 2.5 and the broader S&P’s ratio of 3.2, according to data from Datastream by Refinitiv.
S&P 500 real estate sector versus broader S&P 500 : tmsnrt.rs/2FFUPAU
The rapid gain, driven by low U.S. interest rates and concerns about U.S.-China trade relations as well as economic growth, has given some investors pause and the sector has underperformed in the last five days.
But in residential REITs AEW’s Szymanski favors landlords of single family houses. Companies in this sector include American Homes 4 Rent (AMH.N), up 21.6% so far this year, and Invitation Homes (INVH.K), up 32.1%.
“The demand is strong. There’s decent visibility. Investors aren’t rewarding it with same premium as industries around a lot longer,” said Szymanski.
Cedrik Lachance, Director of REIT Research at Green Street Advisors said residential REITs are benefiting from trends such as “limited supply and pricing power that’s good to great depending on the subsector.”
In single family residential, he said there is strong pricing power, limited supply and strong demand as younger people are looking to move from apartments to houses but – weighed down by student debt – many can’t afford to buy a house.
“Incomes are moving nicely but it’s still challenging to put together a down payment for a home,” he said adding that in multi-family homes, supply and demand are in balance.
The FTSE Nareit equity residential index .FTFN17 has risen 17.8% so far this year, just below the broader S&P REIT index.
The FTSE Nareit Equity Industrial index .FTFN14 has risen 29.1% so far in 2019 making it the biggest gainer of the main REIT subsectors. Investors favor the sector, which include warehouses used by online retailers such as Amazon.com (AMZN.O), over traditional retail malls which have struggled horribly.
The FTSE Nareit Equity Regional Mall index .FTFN2 has fallen 6.4% so far this year. If the Trump administration were to escalate its trade war with China and slap more tariffs on imports as threatened, that could hurt online retailers and hurt warehouse demand, but investors are still bullish.
“There are trade risks but the e-commerce effect has been disruptive,” said Macquarie’s Zenouzi.
Office REIT’s are less popular with the FTSE Nareit equity office index .FTFN15 4.5% in the last 3 months though it is still up 13.5% year-to-date, as investors are less bullish about that’s sector’s outlook.
“We’re cautious about the office business,” said Green Street’s Lachance. “There’s been a fair amount of supply and at the same time there’s been a trend in towards densification. You’re sitting closer to your colleagues than you were before.”
AEW’s Szymanski has a preference for Asia-Pacific and European real estate over U.S. investments but notes that one wrinkle in Europe is the uncertain UK outlook because of Brexit.
Since the U.S. real estate sector has underperformed in the last five sessions with a 4% decline versus the S&P’s 1% drop, Green Street’s Lachance says REIT’s have moved back “squarely into fair value range.”
Wells Fargo’s Head of Real Asset Strategy, John LaForge did not see much upside for REITs, as he expected 10-year yields to rise again this year, adding more competition for high-yielding REITs. But with lingering investor concern about global economic growth and the U.S.-China trade war, he does not expect a big sell-off in the safe-haven sector either.
“People like the safety for now. What would roil them a little bit and shake people out of REITs is if China and the U.S. do a trade deal.” LaForge said.
Reporting by Sinéad Carew, additional reporting by Chuck Mikolajczak, April Joyner and Herb Lash, editing by Alden Bentley and David Gregorio