Which REIT Sectors Will Outperform in 2018?

Among REITs last year, the I’s—industrial, information and infrastructure—had it, and had it in a big way. But will those sectors repeat their great feats in 2018? Or will other sectors bypass them in terms of performance?

In 2017, publicly-traded REITs in the industrial, information (aka data centers) and infrastructure sectors outperformed the other general REIT categories, according to data put together by the National Association of Real Estate Investment Trusts (NAREIT). Infrastructure (cell tower) REITs posted returns of 35.4 percent last year, according to NAREIT. Data center REITs were next (28.4 percent), followed by industrial REITs (20.6 percent).

By comparison, REITs in the FTSE NAREIT All Equity REITs Index delivered an overall return of 8.7 percent in 2017, and REITs in the FTSE NAREIT All REITs Index, which features both equity and mortgage REITs, notched an overall return of 9.3 percent last year.

Brad Case, senior vice president of research and industry information with NAREIT, says that industrial REITs benefited from increased awareness of the sector in 2017.

“Industrial real estate has been around forever and it’s been professionally managed for a long time, but investors became aware in 2017 of the fact that the growth of e-commerce was going to result in a tremendous increase in the demand for industrial space,” Case says.

Matt Werner, managing director and portfolio manager at Houston-based investment advisory firm Chilton Capital Management LLC, also looks favorably upon the industrial REIT sector. But he says the sector might see a cool-off this year because investors may be tired of paying large premiums to NAV and, therefore, may seek discounts in office or retail REIT stocks.

Meanwhile, infrastructure and data center REITs have been buoyed by robust interest among investors in companies that “house” the information technology economy, Case notes. Both of those sectors could replicate last year’s success in 2018, according to Werner.

Although analysts at Deutsche Bank predict 2018 will be another “muted” year for REITs as a whole, they note that industrial and data center REITs will be likely “winners” again this year. Deutsche Bank analysts also put single-family rental REITs in the winner column for 2018.

Currently, Deutsche Bank favors data centers over any other REIT sector, thanks to heightened demand for space and recent global expansion by data center operators.

Among all equity REITs, San Francisco-based financial services firm BTIG LLC forecasts total returns of 4 percent to 6 percent in 2018.

Although REIT performance lagged the overall market in 2017, the industry still delivered a “steady and consistent” return, says Jim Berry, leader of the U.S. real estate and construction sector at professional services firm Deloitte.

“As you look beyond the return and to key operating metrics—such as occupancy, leasing velocity and debt leverage—REITs are generally positive,” Berry says. “The discipline of the overall REIT industry during this economic cycle should continue to provide opportunities for the industry to remain an important part of investing strategies.”

It might be tough for industrial, data center and infrastructure REITs to seize those opportunities at the same level in 2018 as they did in 2017, Case warns, paving the way for other REIT sectors to “gain ground.” Broadly speaking, Case anticipates REITs will rebound relative to the overall market, but he’s not sure whether that will happen this year or in 2019. “We are in the situation where we should get that kind of result in 2018,” he adds. Among the REIT sectors Case expects to make headway is retail.

“Retail during 2017 was so beaten down, and there isn’t really much reason for that…,” he notes. “Investors have really overreacted to the effect of the growth of e-commerce on REIT-owned properties.”

As a result, retail REITs have been punished in spite of the fact that they tend to own higher-quality assets, while it’s lower-quality malls and shopping centers that tend to be hit hardest by challenges like e-commerce, Case says.

“I think regional malls and shopping centers are due for a good year this year,” says Werner, citing the potential for stepped-up mergers and acquisitions activity. By and large, REIT stocks are undervalued, Case says, and stock prices are lower than they should be based on the strength of the industry.

“When investors underappreciate the future growth possibilities for REITs, then what that means is REIT stock prices fall relative to the income that they’re generating,” he notes.

It’s still difficult to forecast how REITs will fare in 2018, according to Werner, so he’s projecting returns of 5 percent to 10 percent this year. That range could be conservative in light of REITs opening the year with a 6 percent to 7 percent discount to NAV and a dividend yield spread approaching 200 basis points versus the U.S. 10-year Treasury yield, he adds.

“There will be further divergence this year between REIT sectors, as well as the specific stocks within the sectors,” Werner says. “Hopefully, investors are attracted to the strong fundamentals that continue to do well for commercial real estate. But if investors think that they’re going to get another 20 percent from the S&P 500 this year, then REITs may struggle.”

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