LDN - Business

Maligned US real estate sector draws buyers eyeing rate cuts

[January 20, 2024] By David Randall

NEW YORK (Reuters) - Falling inflation and expectations of an economic soft landing are buoying hopes for U.S. real estate stocks in 2024, even as the sector continues to lag the broader market.

Real estate investment trusts (REITs) were among the worst performing sectors over the last year, with share prices weighed down by factors ranging from high interest rates to tepid demand for office space in an era of remote work. The Real Estate sector of the S&P 500 fell 3.4% in 2023, while the broad S&P 500 index soared more than 24% last year and hit a record high on Friday.

Real estate's pain has continued into 2024, pushing the sector down 3.4% in January against a 1.4% gain for the S&P 500. Yet some investors are growing more confident the trend will reverse - especially if the Fed cuts rates as aggressively as many investors expect. REITs benefit from lower rates which reduce the cost of capital and fuel revenue growth.

"REITs were crushed by the fastest rate hiking cycle in 40 years, and are going to move in line with expectations of rate cuts," said Justin McAuliffe, a research analyst at Gabelli Funds who remains bullish on REITs such as American Tower.

Investors have been wading back into the sector. Global fund managers increased their exposure to REITs by 15 percentage points in December, pushing allocations to 12-month highs, according to the latest survey from BofA Global Research.

At the same time, the Schwab U.S. REIT ETF - the largest US REIT-focused exchange traded fund- saw approximately $35 million in net inflows over the last week, its largest since October, according to data from analytics firm VettiFi.

Historically, the end of a Fed hiking cycle has been supportive for REITs. Since 1995, public REITs have gained 20.1% in the year following the last rate increase of a cycle, according to data from CenterSquare Investment Management. The S&P 500, meanwhile, gained an average of 10% in the 12 months after the Fed finished the last hike of a cycle since 1980, according to data from Putnam Investments.

"If central banks have truly turned more dovish, the setup for REITs is favorable," CenterSquare wrote in its 2024 outlook.

Of course, the sector’s sensitivity to interest rate expectations can cut both ways: while real estate stocks rallied along with the rest of the market in 2023 on expectations that the Fed would pivot to rate cuts this year, they have been hit this month as some investors recalibrated bets on how aggressively the Fed might ease.

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A Wall St. street sign is seen near the New York Stock Exchange (NYSE) in New York City, U.S., September 17, 2019. REUTERS/Brendan McDermid/File Photo

Jeff Doerfler, director of investment management at Huntington Private Bank, said the declines make some of the stocks in the sector, such as warehouse owner Prologis, more attractive over the long term.

"We're at the start of a cycle where lower cost of capital will drive revenue growth and you'll get an increasing amount of M&A," said Doerfler, who is overweight REITs overall.

A taste of merger & acquisition activity came Friday, when investment management company Blackstone announced that it acquired Canadian real estate firm Tricon Residential for $3.5 billion, an approximately 30% premium to its most recent closing price.

Investors will get readings on the pace of inflation and the economy next week with manufacturing PMI data released on Thursday and personal consumption expenditures data released on Friday, in addition to earnings from 3M, United Airlines and Abbott Laboratories.

Many REITs do not report earnings until later in the quarter, with retail-focused company Simon Property Group scheduled to report its quarterly results Feb. 5 and American Tower scheduled for Feb 21. Prologis missed analyst estimates when it reported results Jan. 17 and cited weakness in freight demand.

Of course, plenty of obstacles remain for the sector - chief among them an oversupply of office space that is unlikely to be absorbed anytime soon.

The shift to hybrid work policies will likely erase $800 billion from the value of office buildings in major ciites worldwide by 2030, consulting firm McKinsey said in July.

Chris Miller, a portfolio manager at Allspring Global Investments, remains bullish on the sector overall but says stocks may need to climb “a wall of worry” over the course of the year.

Still, “we think will see a stabilization of interest rate volatility and that gives us optimism going into 2024," he said.

(Reporting by David Randall; Editing by Ira Iosebashvili David Gregorio)

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