The Federal Reserve’s 25 basis-point increase to the target funds rate does not come as a surprise. Rather, the increase was long due and speaks volumes about the confidence of the Fed in the underlying recovery of the economy.
In other parts of the world, growth worries are intense and an easing mode is being widely adopted by major central banks. In such a global backdrop, this rate hike gives us confidence that the U.S. economy is essentially growing, perhaps at a moderate pace, but surely putting its troublesome past behind.
Sectors like banking, asset management and insurance are sure to rejoice, but what about those sectors that have long benefited from the low rate regime? Specifically, is the game over for the real estate investment trust (REIT) that stood out during the low rate environment with high returns?
REITs are more likely to be hurt with the rate moving north due to their capital-intensive nature. A rate hike would essentially translate to higher interest expense for them. Since they are required to shell out 90% of their income as dividends, the rise in interest expense could lower their dividend payout as well. And above all, their dividend payout itself might become less attractive compared to the yields on fixed income and money market accounts.
Game Over for REITs?
But that does not mean that REITs will perish. Since everything cannot be done virtually, one will essentially need real space for economic activities. And it is here where the property fundamentals come into consideration.
In fact, with gains in employment and growth in wages, buying power is increasing and spending trends are improving. So, economic activity is essentially picking up steam and demand for space is growing. But owing to the economic weakness in the past, supply of new space has been low in most of the real estate categories, leading to favorable demand/supply conditions.
And it is this imbalance that is essentially creating ample room for the real estate landlords to benefit from. Property fundamentals are improving with occupancy gains and landlords being well placed to command higher rents for their real spaces.
Besides, in recent years, REITs have been proactive in the capital market. They have opportunistically used the low rate environment to make their financials more flexible, which is encouraging down the line for their operational efficiencies.
Supporting our view is a NAREIT study, which reveals that out of the 16 periods of significant interest rate rise since 1995, listed equity REIT returns were positive in 12. This implies that REITs actually have higher chances of gathering steam amid rising rates.
What Action Should You Take on REIT Stocks Now?
A near-term hiccup cannot be avoided. But this might actually imply a golden opportunity for investors to accumulate some good REIT stocks in their portfolio.
Even our Zacks Methodology, which ranks all of the 260+ industries based on the earnings outlook for the constituent companies in each industry, reveals this optimism. This is because most of the categories of REITs enjoy a top slot in that ranking list now and therefore have an overall solid positive outlook for the near term.
REIT Equity Trust – Retail is currently ranked #38 (top 14%), while REIT Equity Trust – Residential and REIT Equity Trust – Other are at #39 (top 15%). Only REIT Mortgage Trust is presently ranked #201 (bottom 24%), raising concerns.
(To learn more visit: About Zacks Industry Rank).
And why not? The 5.1% average rent growth from Jan–Oct 2015 against 3.6% growth during the comparable period a year ago, as per data from Axiometrics, well reveals the market’s strength. Even retailers have increased the number of store openings for the next two years with 42,554 planned for next year and 79,655 for the next two, per an article from the National Real Estate Investor site that cited an August report from RBC Capital Markets.
Stocks to Consider
Selecting stocks from the top REIT categories seems appropriate. We screened for stocks with a favorable Zacks Rank. A Zacks Rank of #1 (Strong Buy) or #2 (Buy) indicates high chances of outperforming the market over the next 1–3 months. Along with high ranks, we looked for stocks with good growth potential and for that we relied on our style score system, according to which a stock with favorable Zacks Rank and Zacks Growth Style Score of ‘A’ (or ‘B’) is highly desirable.
Here are four such stocks for your consideration:
Essex Property Trust Inc. ESS
The company enjoys concentration of assets in select coastal submarkets along the West Coast, including Southern California, the San Francisco Bay Area, as well as the Seattle metropolitan area. Notably, in Apr 2014, Essex Property completed the merger with BRE Properties that led to the creation of a premium West Coast pure play multifamily REIT.
The stock currently carries a Zacks Rank #2 and a Growth Style Score of B. Projected EPS growth is 14.07% against the industry average of 9.65%. Further, projected sales growth is 22.35% against the industry average of 9.38%.
Retail Opportunity Investments Corp. ROIC
This San Diego-based retail REIT is engaged in the acquisition, ownership, and management of necessity-based community and neighborhood shopping centers in the U.S.
The stock currently carries a Zacks Rank #2 and a Growth Style Score of B. Projected EPS growth is 12.24% against the industry average of 6.80%. Further, projected sales growth is 22.48% against the industry average of 2.33%.
Outfront Media Inc. OUT
New York-based Outfront Media, formerly known as CBS Outdoor Americas Inc., is a lessor of advertising space on out-of-home advertising structures and sites across the United States, Canada and Latin America.
The stock currently carries a Zacks Rank #2 and a Growth Style Score of B. Projected EPS growth is 153.51% against the industry average of 7.73%. Further, projected sales growth is 9.13% against the industry average of 8.45%.
CoreSite Realty Corporation COR
Headquartered in Denver, CO, Coresite Realty provides data center products and interconnection services to telecommunications carriers, content and media entertainment providers, cloud providers, enterprise customers, financial and educational institutions, and government agencies.
The stock currently carries a Zacks Rank #2 and a Growth Style Score of A. Projected EPS growth is 28.29% against the industry average of 7.73%. Further, projected sales growth is 10.87% against the industry average of 8.45%.
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