by Bryan Perry
May 31, 2023
This past week’s consumer and inflation data came in a bit hotter than forecast, pushing up interest rates further and increasing the odds that the Fed will raise the Fed Funds Rate in June to 64.2%, up sharply from 17.1% a week ago. This will take the rate up to 5.25%-5.50% and be the 11th straight rate increase.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
This rate-rising environment has been a stiff headwind against the overall REIT sector, as the cost to develop and maintain properties has outpaced lease increases for many REIT operators stuck with long-term leases. But not all REITs are created equal, for sure, and those than can adjust terms for tenants on a more frequent basis stand to weather the inflationary pressures the best. They will also have the best chance of rebounding when money starts flowing back into the sector in general.
This is when I want to have a short list of those REITs in the multi-family residential REIT space, where higher home prices, higher mortgage rates, and rising uncertainty about job security are keeping millions of potential home buyers on the sidelines, seeking full-featured Class-A apartments in which to reside.
As REITs are capital intensive by nature, any rate relief later this year could have a meaningful impact on the heavy debt loads that REITs typically have. When the Federal Reserve does (finally) pivot on rates, it could potentially help restore investor confidence, and mark “a cyclical low,” as Brent Dilts, a real estate analyst at Columbia Threadneedle Investments recently told Barron’s. Dilts pointed out that “REITs tend to outperform the broader stock market 18 months after the Fed ceases hiking interest rates.”
In that same Barron’s article, Michael Knott, Green Street’s head of U.S. REIT research, said “Publicly traded real estate is less expensive than property in the private market…a cheaper way to buy real estate.”
Besides apartment REITs that tend to be all-weather, self-storage properties and healthcare facilities that service primarily consumers and small businesses also fit this ballast real estate profile. Similar to multi-family rental properties, owners of self-storage and healthcare properties are able to raise tenant rents and leases more frequently (to adjust for inflation) than those who own long-term leases for office buildings, industrial properties, retail shopping centers, data centers, infrastructure, and other specialty REITs.
One such example is the iShares Residential and Multisector Real Estate Fund ETF (REZ). It has strong exposure to the self-storage sector, Class-A apartments, and some healthcare facilities, all of which are more defensive in a slowing economy, where the narrative of recession is still an ongoing topic of concern for investors. The broader real estate market is highly fragmented with single-family home prices holding most of their 5-year gains due to extreme supply shortages in the most desirable markets, while many sectors of commercial real estate are selling at steep discounts from their pre-Covid highs. It is a tale of two markets, yet some commercial property REIT valuations are trading at very attractive levels.
Looking at the long-term chart of REZ (below), the stock took a big hit during the Great Recession of 2008-2009 followed by another big sell-off in 2020, during the COVID-19 pandemic, and once more this past year in the wake of those 10 consecutive Fed rate hikes. Shares of REZ are down just over 31% since hitting a high of $100 in April 2022, at the time of the first rate hike. The fund pays a dividend yield of 3.45%, which isn’t nearly as attractive as other REITs, but the quality of the holdings is very good, and it should respond in a bullish manner when the market gets a whiff of a Fed pause on monetary policy.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
The growing chatter about the economy bracing for some degree of recession has been taking hold for some time. The evidence of stagflation is evident within certain pockets of the economy, with many leading companies providing cautious forward guidance, citing macro-economic conditions. The Fed may have one or even two more rate increases in sight, but it is important to do some early due diligence in the real estate market, where excellent assets are on sale and trading at steep discounts to their previous highs.
When the market rotates back into REITs, it should prove to be a very lucrative investment class to own.
All content above represents the opinion of Bryan Perry of Navellier & Associates, Inc.
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Bryan Perry
SENIOR DIRECTOR
Bryan Perry is a Senior Director with Navellier Private Client Group, advising and facilitating high net worth investors in the pursuit of their financial goals.
Bryan’s financial services career spanning the past three decades includes over 20 years of wealth management experience with Wall Street firms that include Bear Stearns, Lehman Brothers and Paine Webber, working with both retail and institutional clients. Bryan earned a B.A. in Political Science from Virginia Polytechnic Institute & State University and currently holds a Series 65 license. All content of “Income Mail” represents the opinion of Bryan Perry
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