Trepp: REITs May Reach Plateau

Real estate investment trusts ended February with relatively flat performance following some ups and downs, reported Trepp, New York.  

Trepp Senior Director of Research Susan Persin said positive performance by mortgage REITs largely offset equity REIT declines. “Current REIT performance reflects broader market behavior, but could also signal that markets may be plateauing,” she said.

The FTSE/NAREIT All REIT Index fell 29 basis points during February, while the broader S&P 500 index fell 10 basis points.

“Real estate market fundamentals are healthy, evidenced by strong demand and supply that is mostly in check,” Persin said. “Real estate asset values are high, benefitting [REITs] that are selling properties, but making acquisitions more difficult.”

Steven Marks, Managing Director with Fitch Ratings, New York, said many REITs are moving to a “build-over-buy” approach to growth as they find it increasingly difficult to purchase affordable assets.

“It’s tough for companies to buy right now,” Marks said. “Assets are expensive. Cap rates for institutional-quality real estate are at all-time lows, particularly in gateway coastal markets.”

In addition, he noted that public REITs find it hard to compete with private buyers such as insurance companies and private equity funds because those buyers typically have higher leverage thresholds than REITs.

“Second, REITs are trading below their net asset value,” Marks said. “That combined with low cap rates makes leverage-neutral assets expensive.” He said REITs currently trade at a 13 percent discount to net asset value.

“Third, companies with in-house development expertise typically have migrated to building over buying,” Marks said.

Persin said lodging REITs experienced a particularly strong February, with total returns up 7.62 percent. “Late in the month, Hilton Worldwide confirmed plans of a REIT spin-off for 70 mostly-domestic owned properties totaling 35,000 rooms,” she said. Manufactured-home and free-standing retail REITs also performed well, up 4.23 percent and 3.36 percent respectively.

“For now, real estate market fundamentals are strong and capital continues to flow into the REIT sector,” Persin said. “REITs, with their current 4.05 percent dividend yield, remain attractive in the current low interest rate environment. However, recent REIT performance also indicates that some investors expect the pace of growth to decelerate, especially since low oil prices and global economic issues are affecting the U.S. energy and technology industries.”