- Happy Holidays!
- Have a great week!
- Thank you for the opportunity to be of service.
It was a tough week for REITs as rates across the coupon curve rose on the expected impact of tax reform and the growth/inflation that might accompany it. Despite decent retail sales and the benefit of tax reform on pass through vehicles, REITs underperformed the broader market by over 250 basis points.
We believe this has just made the sector more attractive and should help drive returns going forward. We continue to be optimistic for the sector in the coming year due to tax reform and the strong underlying fundamentals of the sector. See my recent article on Tax Reform HERE.
An overview of the market from last week:
Interestingly, retail focused took both the best performing and worst performing spots last week, with the resilient Urstadt Biddle underperforming and turning in a negative 7.84%, while CBL & Associates was up 2.2% on the week.
The dividend yield by sector:
REITs continue to outyield the broader market, which we continue to believe will be a supporting factor in the coming year.
A snapshot of price to expected FFO by sector:
Of course, the REIT sector (and equities generally) don’t exist in a vacuum, and must also be considered versus the various asset classes available to investors:
For income focused investors, there are only a few other sectors that can compare, and high yield and emerging markets have come under pressure in recent days as both are somewhat stretched and investors are reallocating their risks.
The one-week total return by sector shows the varying levels of negative performance over the last week:
Similarly, most of the other asset classes were weaker on the week, with only broader equity markets and high yield generally outperforming. Another interesting point is the outperformance of global (ex-US) real-estate. Investors have been looking at Europe for cheaper real-estate plays as well as Asia.
On a year-to-date basis, only retail and campus housing have turned in negative results. We will be taking a closer look at campus housing in the coming days in order to dig deeper into the reasons behind the underperformance despite the growing opportunities within the space.
Mortgage REITs, on the other hand, have benefitted from the rather benign interest rate environment (and the impact upon both funding rates and prepayments). Commercial mREITs have underperformed despite their relative security versus agency and hybrid/resi mREITs. We expect this to turn during the coming year as the Fed continues to unwind its balance sheet and rate volatility impacts prepayment rates and hedging.
The dividend yields available within the mREIT space continue to be high versus most other asset classes, but we have been hearing more analysts express concern about their ability to maintain their dividends in the current (and expected) environment.
While we prefer the commercial mREIT space, we do worry about the relative valuation of the sector and are digging into the data in order to ascertain what the valuation gap should be.
As commercial mREITs are more prone to resemble their equity REIT cousins, they are the only sector to turn in negative results on the year.
As we stated in the beginning of this note, the Treasury coupon curve backed up over the last week, with the longer end of the curve some 13-14bps cheaper:
As the following chart shows, the curve is higher and flatter than a year ago, which, if continued, will pressure the returns on banks and mREITs:
Finally, the VIX. Volatility continues to avoid the equity market (must be concentrated on bitcoin), which does not really sit well with us as we believe there are pressures building within the broader equity market that are not being reflected in volatility or valuation.
Have a great holiday week, we hope you have happy, healthy and safe holidays!
Recent article below:
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.