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REITs Off to a Rocky Start in 2015

REITs Off to a Rocky Start in 2015

After posting stellar returns last year, REITs have come crashing back to earth with a dismal performance in 2015.

In fact, year-to-date total returns for all equity REITs as of May 28th were still hovering in negative territory at -0.32 percent, according to the FTSE NAREIT US Real Estate Index. That is a far cry from the 27.15 percent total returns the sector posted in 2014.

“Year-to-date it has not been the best year. The sector had been up in the first quarter, but the month of April was not a good month for REITs,” says Brad Case, senior vice president, research and industry information, with the National Association of Real Estate Investment Trusts (NAREIT) in Washington, D.C.

There are a couple of reasons for the sluggish start. One is just the general state of the economy. “REITs are not alone to have suffered from the softening macro-economy,” says Case. The fundamentals for real estate remain solid. Vacancies are improving across the board in different property sectors, while new supply remains in check. What has happened is that renewed concerns about rising interest rates have created some jitters among investors.

Recent increases in interest rates and fears of a further rise have spooked the REIT market, given its sensitivity to bond yields, agrees Michael Knott, managing director with research firm Green Street Advisors.

“REITs may be in for a tough year, but there are reasons to believe that rates will not spike infinitely upward, but instead that low rates may be with us for a while, given tepid macroeconomic conditions around the globe and excessive debt that still defines our financial landscape,” says Knott.

Winners and losers

So who are the winners and losers in the current climate? Property sectors that have been out-performing include self-storage and housing, both apartments and manufactured homes. The self-storage sector has posted the highest REIT returns year-to-date at 9.2 percent, according to the FTSE NAREIT Index.

Typically, self-storage appeals to people in transition who need a place to park their belongings. But there is also growing demand from business owners who need to store inventory, equipment or documents, adds Case. “Both households and businesses have found this a reasonably cost-effective way to manage things that they don’t need every day,” he says.

Apartment REITs have been another clear leader, with year-to-date total returns of 5.3 percent. “We have been bullish on apartments, and it has been a relative winner in 2015,” says Knott. Better job growth among 25- to 34-year-olds, fewer kids moving back in with mom and dad and a lower homeownership rate are a few of the factors fueling demand for rentals, he adds.

On the losing side, some of the biggest laggards have been lodging/resort REITs at -8.1 percent; industrial REITs at -6.0 percent and healthcare REITs at -5.4 percent. “Hotels have underperformed, as there seems to be a case of nervousness that the party is getting late,” says Knott. Some investors are also wary about the new supply that has been introduced in some markets.

The drop in industrial returns could very well be a temporary phenomenon as the sector saw some negative backlash from the West Coast port strike. However, there also has been an overall softening in manufacturing output, both in the US and globally, during the first quarter of the year.

“So that is something that could have led people to expect a bit less demand for industrial facilities going forward, and that could weigh on the sector,” says Case.

The healthcare sector has been hit hard by worries over rising interest rates. The sector is perceived to be more rate-sensitive as it tends to offer a higher yield and reasonable stability, but less growth, says Knott. There are also some other factors at play that have negatively impacted healthcare REITs, such as slowing growth in demand for seniors housing, growth in new supply and rising wages. The latter is important because seniors housing margins are far lower than those for most forms of real estate, and the sector has far more operating leverage, he adds.

Despite the rocky start, there is a chance that REITs could bounce back later this year.

“After a year where they have had strong double digit returns and very strong performance for the last couple of years it is not surprising to have a stretch of a couple of months where it is weak,” says Case. It is important to note that real estate fundamentals remain strong, and it is not very likely that interest rates are going to rise rapidly. “So those are all very favorable for the medium term investor for the REIT sector,” he says.

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