“Property fundamentals remain solid, but the rate of property-level cash-flow growth seems to be slowing somewhat and suggests the market is at a minimum mid-cycle on a fundamentals basis,” the report said, adding that relative to weak S&P 500 earnings growth due to a slower global economy, REIT earnings growth in 2015 and 2016 is “very healthy.”
Sector Spotlight
As represented by the FTSE NAREIT All Equity REITs Index, equity REITs last year registered a loss of 0.98% on a price basis. Thanks to a dividend yield of 3.85%, the index’s total return was 2.83%.
Not great, but it slightly beat the S&P 500, which lost 0.7% on a price basis but had 1.4% in total returns after including dividends, which amounted to a collective yield of 2.12%. And it beat the negative 1.03% price return and 1.01% total return on the S&P Composite 1500, which NAREIT uses as a comparison because, like the NAREIT index, it includes large-, mid- and small-cap stocks. The yield on that particular index was 2.07%. (The FTSE NAREIT Mortgage REITs Index fell more than 18% on a price basis and dropped nearly 9% on a total return basis last year, and sported a yield of 12.15%.)
Real estate is a multifaceted industry ranging from apartments and self-storage units to nursing homes and cell towers, along with traditional shopping malls and office buildings. Thus, different sectors can diverge as they react to their own peculiar dynamics.
While returns on most REIT sectors were in the black last year, underperformers tracked by NAREIT included offices (0.29%), timberland (minus 6.97%), health-care facilities (minus 7.25%) and lodging/resorts (minus 24.42%).
The big winners in 2015 were self-storage facilities (up 40.65%), manufactured homes (25.65%) and apartments (16.45%). But it’s common in investing that last year’s winners aren’t repeat winners next year because many investors, especially institutional ones, tend to rebalance their portfolios.
For those who want exposure to REITs, the simplest way is through a diversified fund. Clark Capital Management Group, a Philadelphia-based investment advisor, employs a top-down, relative-strength-driven methodology that leans heavily on ETFs, and as part of that it owns the SPDR Dow Jones REIT ETF (RWR) in several strategies it runs for financial advisors and their clients.
“We think one thing working in favor of REITs at present is the overall risk-off and defensive tone of the market, which has us defensively positioned in sectors such as REITs, utilities, consumer staples and low-volatility ETFs,” says Sean Clark, the firm’s chief investment officer.
But that could change if the markets follow the historical pattern set during presidential election years: weak performance early on followed by a strong rally at year’s end. “If a risk-on environment comes back into vogue, then our defensive posture would revert, and real estate, utilities and staples would probably fall off our radar screen and we wouldn’t own them,” Clark says.
He notes that for longer-term investors, REITs make sense at some weight depending on their objectives. “We take a more tactical view in how we allocate to them,” he says.
Of note to REIT investors are two factors that could be helpful to real estate in 2016. First, changes made in December to the Foreign Investment Real Property Tax Act make it easier and more tax-efficient for foreigners to invest in U.S. real estate. In a recent report, UBS analyst Jonathan Woloshin said these measures are “clearly beneficial to REITs and commercial real estate.”
And REITs could get a boost in August when real estate becomes the 11th sector classification in the GICS (global industry classification standard) system created in 1999 by MSCI and Standard & Poor’s.
The new real estate sector will include equity REITs, along with real estate management and development companies, which currently reside in the financials sector. Mortgage REITs will remain in the financials sector. Some analysts believe this new designation will boost awareness and demand for listed real estate, potentially resulting in a greater flow of capital into REITs. What that’ll mean for REIT stock prices remains to be seen.