Displaying items by tag: rate hikes

Many contrarian investors are certainly interested in buying the dip in REITs given the low valuations, generous yields, and upside in the event of a Fed pivot. Further, many components of the real estate market remain healthy such as healthcare and industrials. However, there are some risks that investors need to consider.

There are secular problems in areas like retail and office buildings due to oversupply, while there have also been significant changes in people’s behavior, affecting demand. Additionally, investors should be aware that every bear market results in a handful of value and yield traps which become plagued by balance sheet and liquidity issues especially in high-rate environments.

Value traps are situations in which stocks look attractive by conventional metrics, however these low valuations are a reflection that the market isn’t optimistic about the company’s prospects. Similarly, ‘yield traps’ are when yields look attractive, but the market is expecting a dividend cut as current payout ratios are not sustainable. 

For investors interested in REITs, they must prioritize quality and strong financials. This is especially true in the current situation where the path and trajectory of monetary policy remains highly uncertain. If rates do stay elevated for a long period of time, some REITs will go bankrupt, while many will have to pay their dividends in order to remain solvent. 

Finsum: REITs are attracting interest from contrarian investors, but here are some downside risks to consider.

REITs are in the midst of another leg lower and have effectively wiped out their gains from May and July with a 9% decline over the past six weeks. Year to date, the sector is down by 7% while it was up as much as 9% at its highest point in the year as measured by the Vanguard Real Estate ETF. This follows even steeper, double-digit losses in 2022.

In recent months, the weakness of the long-end of the Treasury curve has hit all types of yield-generating assets like REITs and dividend-paying stocks. Fed fund futures markets are downgrading the chances of rate cuts in 2024 while extending the duration that rates will remain at these levels. There is even increased chatter about how the Fed’s terminal rate must even go higher in order to truly stamp out inflation.

It’s a double-edged sword for REITs as the bulk of the sector continues to deliver impressive financial results with defaults remaining low especially in areas with strong fundamentals like healthcare and industrials. Yet, the stocks are unlikely to rally as long as rates remain elevated at these levels even despite attractive yields.

Finsum: REITs are in the midst of another leg lower and falling to new annual lows due to an uptick in inflationary pressures and the Fed coming out more hawkish than expected.

REITs have languished in 2023 despite a buoyant equity market due to concerns of cascading defaults in certain segments like commercial real estate (CRE), while high rates continue to pose a significant threat to the group. However, the group is beginning to look attractive from a valuation perspective while offering generous dividend income to holders as well.

From a contrarian perspective, there are some silver linings. For one, yields on long-term Treasuries are hitting levels at which they have found resistance before. The biggest, recent headwinds for REITs has been the increase in long-term rates. If this were to reverse, it would be a major catalyst for the group by lowering their financing costs and making their dividends more attractive. 

Additionally despite the challenging operating environment, financials continue to be sound, outside of CRE, and dividends continue to be hiked. According to research, REIT stock prices tend to follow their dividend streams over long periods of time. So far, there is no evidence that dividend payouts will be compromised which increases conviction in buying the dip.

To reduce risk, investors should focus on areas where rents continue to increase such as healthcare and industrials in contrast to areas where rents are slowing or stagnating such as multifamily real estate and office properties. 

Finsum: REITs have been one of the worst performers over the last 2 years. Here is a contrarian perspective on why the sector could outperform in 2024.

2023 has seen a modest rebound for REITs despite rates continuing to move higher, no indications of an imminent Fed pivot, and a serious crisis in commercial real estate. One factor is that overall revenues have stabilized and balance sheets remain healthy. Another factor is that healthcare and industrial REITs are seeing revenue growth at a nearly double-digit rate despite the headwind of higher rates. 

During Q2 earnings season, funds from operations climbed 4.2% compared to last year’s Q2, totaling $20.6 billion. There is also no compromise in terms of financing with 79% of REITs using unsecured debt with 91% of overall debt locked in at fixed rates, meaning there is less sensitivity to rates. 

Another silver lining is that leverage ratios remain below 35% while the average term to maturity is close to seven years. In total for publicly traded REITs, the cost of capital is currently 4%. Given these financials, REITs are also better to take advantage of turmoil in real estate markets as they will be able to access financing at a lower cost of capital than private market operators. 

Finsum: Q2 earnings season is over. The much maligned REIT sector continues to see stable revenue growth and healthy financials despite a challenging environment. 

Over the last couple of years, REITs have been one one of the weakest parts of the market. REITs own and operate income-producing real estate and are obligated to distribute more than 90% of profits to shareholders.

The biggest headwind has been the relentless rise in rates which makes these stocks’ dividend streams less attractive and ups their financing costs. Higher rates also impact demand for housing by making it less attractive. Finally, there is a crisis in the commercial real estate (CRE) space due to low occupancy rates for offices given the increase in remote work.

While there have been an array of macro and cyclical factors negatively affecting REITs, there are some reasons for optimism that the worst may be over. For one, the odds of a soft landing continue to rise. This is due to recent economic and labor market data which clearly show that the job market is cooling, and wage growth is falling. However, job losses have not been materially rising, indicating a period of slower growth rather than a recession.

This should lead longer-term rates to drift lower which would be a catalyst for REIT stocks to start moving higher. Lower rates should help housing demand. Additionally, a weaker job market could also give employers more leverage to force workers to return to the office. 

Overall, many of the negative trends which were impacting REITs are now reversing.

Finsum: Recent economic data is strengthening the odds of a soft landing. Here are why REITs would be a big winner in this scenario.