REIT Fundamentals Look Good
The slowdown in the housing market, which has led to a huge pullback in the home-building stocks, now appears to be hitting real estate investment trusts (REITs), which invest in real estate either directly (by owning and managing properties) or indirectly (by buying mortgages).
Since the start of the year, all six categories of REITs in the Standard & Poor's Composite 1500 index of U.S. stocks have lost value. Residential REITs, which own apartment buildings, and office REITs, which focus on commercial office space, are both down around 5 percent so far this year. Retail REITs, which own malls and other retail-related properties, have lost nearly 7 percent on average.
This represents a huge turnaround, as REITs in general have returned nearly 29 percent a year for the past five years, according to Morningstar. "This erosion in performance has caused many to ask, 'Is this the beginning of the correction in real estate stocks?' " says Sam Stovall, chief investment strategist for Standard & Poor's.
Not necessarily. At least not for these REITs, which throw off a decent amount of income through the rents they collect. In fact, Standard & Poor's maintains either a "positive" or "neutral" outlook on all six REIT categories in the S&P Composite 1500.
Here's a look at S&P's thoughts, drawn from its "Global Equity Insights" report released this month, on each of the six major REIT sectors:
INDUSTRIAL REITS
What are they?
This group specializes in industrial or warehouse space.
What's S&P's take?
"We have a positive fundamental outlook on the group. Industrial REITs have historically been economic laggards. In fact, we think the group is just now beginning to fully recover from the effects of the last recession, which prompted users of industrial real estate to jettison unnecessary space, causing rental rates to decline...With the real U.S. [gross domestic product] expected to rise moderately and increased demand for industrial space, we believe same-property revenue and funds from operations will likely be positive across the industry over the next 12 months."
What trends are working either in favor of or against industrial REITs?
The resilient U.S. economy—and the accelerating global economy—should provide a tailwind to this group, especially those real estate investment trusts whose properties cater to businesses that deal in international trade.
OFFICE REITS
What are they?
This group specializes in office buildings and commercial office space.
What's S&P's take?
"Our fundamental outlook on the office REITs subindustry group is positive, based on continuing U.S. employment growth. We also believe positive net absorption of office space will lead to moderately rising rental rates on average and continued growth in cash flow from cyclical lows. The U.S. office market tends to track the overall economy on a lagged basis, reflecting an average lease term of seven to 10 years."
What trends are working either in favor of or against office REITs?
The resilient U.S. economy—and the accelerating global economy—should also provide a tailwind to this group. Low unemployment and decent job growth are also expected to boost rents, which should increase the dividend income these REITs generate. And S&P believes office rents should rise now as office space is becoming scarce. In 2003, for example, the national vacancy rate for office space stood at 17 percent. At the end of 2006, it was closer to 13 percent.
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