REITs (real estate investment trusts) are indispensable part of the US economy because it encompasses real estate businesses that build, manage, lease, mortgage, buy and sell properties across the entire real estate industry from residential, retail, office, industrial, healthcare, self-storage, specialty, data center, timberland, infrastructure, and lodging (hotels and resorts) REITs. Most of the industry revenue that is generated is from income-producing real estate, which is owned and managed by REITs and then rented out to tenants. The other portion of industry revenues is from mortgage REITs, which provide financing for income-producing real estate. Because the REIT industry spans the entire real estate industry its performance is largely affected by the nationwide business activity and the economy. When the global recession ended home prices were continuing to fall and foreclosures were damaging the industry. This was evident through high vacancies and plummeting prices throughout the industry. Although some segments of the REITs industry were more affected than others. Since then there has been a turnaround in the real estate industry as vacancy rates reached to 90 percent throughout most segments.
The big story for in REITs in 2017 was how they underperformed the broad stock market, which can be a little bit misleading. According to the FTSE Nareit All U.S. REITs index the industry generated a total return of 9.27 percent, which is just below the 45-year average of 9.69 percent. In 2017 the REIT market was overlooked and undervalued, but as it stands it really had normal returns, but just not compared to the abnormal returns in the other segments of the markets. The fundamental business for REITs is managing their real estate assets to produce strong operating performance by maintaining high occupancy rates and strong rent growth. Overall, REITs have been able to have consistent growth in net operating income (NOI), which ranges from 2.5 percent to 4 percent a year. As of right now the REIT industry is right where it should be at 3.2 percent over the last four quarters.
The industry is likely to remain on steady footing, which should be driven by demand and supply condition in the real estate market. The GDP growth for 2018 should be between 2.2 and 2.5 percent, which will support the growth of the REIT industry. Supply conditions are also favorable as construction has slowed down slightly in 2017, which has moderated the concerns of an oversupply problem. The real estate industry average occupancy rate has steady in the 93 to 94 percent range over the past four years.
REITs are going to be more in the spotlight during 2018 because it was overlooked and undervalued throughout 2017. Overall, the operating environment for REITs has been solid, both demand and supply drivers have been favorable, and it is expected that this type of environment should continue throughout 2018 and for some years to come.
Some threats that need to be kept in mind are GDP, inflation and interest rates. Although GDP is expected to continue to help the growth of the real estate industry it is important to keep in mind the possibility of overbuilding, overheating, over-leveraging, which could lead to recessions. Also, inflation has been below the Fed’s 2 percent mark and it is important that inflation rates don’t fall too far because it limits the Fed’s ability to boost the economy, but they also don’t want rates to overheat as well. Lastly, interest rates have ranged between 2.00 and 2.50 in 2017 and it is expected that interest rates should rise and remain in the 2.50 to 3.00 percent range.
Industry Life Cycle
The REIT industry is usually on cycle with the movements of the economy. Movements in GDP, interest rates, property prices, and inflation all have an effect on the economy and therefore the industry. As mentioned above the GDP is expected to continue to have slow growth, which means that the REIT industry should be in a growth phase. REITs have been overlooked and undervalued throughout 2017, which could lead to a growth phase and plenty of opportunities throughout 2018 and for a few years.
Charlie Izaguirre contributed to this report. For a detailed list of sources, click here.