Rising interest rates and the weakening economy have crushed real estate investment funds in 2022, with the FTSE Nareit All Equity REIT index down 23% year to date.
Rising rates hurt REITs because they borrow money to buy real estate and because higher yields make bonds, which are generally safer investments, more attractive compared to REITs.
Meanwhile, a slumping economy reduces demand for real estate.
But REIT declines could reverse as early as next year, assuming the Federal Reserve stops raising interest rates.
Here are some of the strongest real estate sectors, all of which I’ve invested in myself, including the stocks mentioned.
Rising house prices and exploding mortgage rates have made owning a home unaffordable for many of us. That means strong demand for multi-family homes.
REIT’s largest apartment is AvalonBay Communities (AVB) – Get a free report.
The company “owns and operates high-quality multifamily properties in urban and suburban coastal markets with demographic characteristics that enable AvalonBay to maintain high occupancy rates and drive strong rental growth,” Morningstar analyst Kevin Brown wrote in a comment.
Those areas are New England, New York/New Jersey, the Mid-Atlantic, Southern California, Northern California, and Seattle.
“These markets exhibit characteristics that create strong demand for apartments, such as job growth, income growth, declining home ownership, high relative costs of single-family homes and attractive urban centers that attract younger people,” Brown said.
He estimates the fair value of the stock at $250, 48% above its recent price of $169. It yields 3.75%.
The explosion of e-commerce in recent years has increased the importance of warehouses and distribution centers, which are a large part of industrial REIT holding companies.
Warehouse/distribution center owners embarked on a massive construction boom during the pandemic as e-commerce boomed. With online purchases slowing down, the warehouse sector is oversupplied.
But buying over the internet still has a lot of room for growth. E-commerce accounted for only 14.8% of retail sales in the third quarter. That total will undoubtedly increase in the coming years.
The largest industrial REIT is Prologis (PLD) – Get a free report.
“The company continues to benefit from historically low vacancy rates in industrial properties,” Morningstar analyst Suryansh Sharma wrote in a comment. “The commercial property market remains strong.”
Certainly, “we are seeing some signs of moderation,” he said. “We believe that weaker macroeconomic conditions, slower e-commerce adoption and a strong supply pipeline will result in the normalization of occupancy and market rental growth… in the coming years.”
Sharma estimates the share’s fair value at $118, 1.7% above its recent price of $116. It yields 2.72%
REITs for data centers
Data usage is mushrooming and much of it takes place in the cloud. This requires boatloads of computer and telecommunication equipment, which are stored in data centers. The need for data should only increase, which will serve this REIT industry well.
The largest data center is REIT Equinix (EQIX) – Get a free report.
The company “exceeded our revenue and earnings expectations in the third quarter and indicated that the business has remained strong, implying solid results should continue at least into next year,” Morningstar analyst Matthew Dolgin wrote in a commentary.
“Management did not dismiss the potential effect of a weak macroeconomic environment, but the company is showing no signs yet, leading us to believe that the secular move to cloud providers and interconnected data centers is unbroken.”
To be on the safe side, Dolgin thinks the stock is currently overvalued. He estimates the fair value at $570, 15% below the recent price of $673. It yields 1.83%.
Mobile Phone REITs
Mobile phone usage continues to rise, with people using their mobile devices for everything from watching TV to buying plane tickets.
In order for cell phones to work – everyone hates those dropped/interrupted calls – telecom providers like Verizon, AT&T and T-Mobile need to have antennas on cell phone towers. So the owners of those towers are in the catbird seat, charging the porters for rent.
The largest owner of mobile phone towers is American Tower (AMT) – Get a free report.
“We believe American Tower’s strategy to diversify its tower portfolio globally places the company in the best position of the three U.S. tower companies as it is poised to capitalize on the ever-increasing demand for mobile data worldwide,” Dolgin wrote.
“However, we don’t think the move into the data center business, which it did with the CoreSite acquisition, will pay off, and it distracts from the tower focus that we liked for American Tower.”
Dolgin estimates the fair value of the stock at $210. It recently traded at $213, 1.4% above fair value, and has a dividend yield of 2.92%.
The author owns stock in AvalonBay Communities, Prologis, Equinix and American Tower.