3 reasons REITs will outperform

Improving fundamentals and low financing costs boosted REITs this year.

But investors steered away from the trusts as interest rates spiked, says Jason Yablon, global portfolio manager at Cohen & Steers in New York. His firm manages the Renaissance Global Real Estate Fund.

“There was a negative impact on prices…and that was a function of people believing REITs can’t do well in rising-rate environments,” he adds.

The problem is some real estate players can’t adjust to change when rates surge too quickly, says Yablon. While hotel owners can adjust rents and occupancies at any time, those who own net lease properties may have 15-year fixed leases that include annual rent bumps of 2%, for example. They can’t adjust to offset inflation.

REITs connected to the latter properties are “more bond-like in nature,” so you have to consider what type of real estate you’re investing in, says Yablon. In general, “most [trust] asset classes will benefit from improving economic environments and not just [suffer from] the negative effect of higher financing costs.”

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The reality is the trusts have historically performed well, which you can see when measuring that performance over a long time frame. “As the economy improves, the owners of commercial real estate can fill up their space,” he adds. This means occupancies increase, owners can raise rents and revenues go up.

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In the current environment, REIT stock prices have indeed improved. Yablon predicts this trend will continue since “REIT prices [have] moved up…since stocks are cheap and fundamentals remain” positive.

The three main reasons REITs will continue to outperform are:

• as jobs are created, the demand for commercial property will grow;
• commercial property supply is minimal; and
• these two factors combined mean we’re creating positive net operating income growth, and rents and occupancies for commercial space are going up.

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“REITs are at a point in the cycle where they can outperform,” says Yablon. “They’re generating 10% earnings growth this year and 7% dividend growth, and the stocks are more reasonably priced today versus where they were a couple of months ago.”