Market Commentary | November 18, 2021

Real Estate Sector Rating: Neutral

The Real Estate sector includes equity real estate investment trusts (REITs) and real estate management and development.

The fallout from the COVID-19 pandemic continues to be a source of uncertainty for the Real Estate sector, but mass vaccinations and relaxed restrictions on public gatherings have reduced investor pessimism. Fiscal relief packages have staved off massive retail lease defaults, but elevated residential delinquencies still pose risks—particularly after the Centers for Disease Control and Prevention (CDC)’s eviction moratorium expired in late August—though improvements in the job market could mitigate this risk. The outlook for office REITs is likely to be uncertain until it becomes clear whether there will be an enduring shift toward remote working—although the recent trend appears to be for most workers to eventually return to the office. Nevertheless, increases in office building inventories are likely to weigh on lease prices and potentially property valuations.

There are some exceptions, however. Warehouse/distribution center demand remains strong, resulting in rising rents. And with the rapid rise in home prices amid low interest rates and de-urbanization, REITs specializing in single-family home rentals and manufactured homes stand to benefit; this is translating into higher multi-family rents, as well. If the economic expansion continues, workers return to offices, and interest rates stay relatively low, the Real Estate sector could do very well. In a generally still-low interest rate environment combined with renewed demand for office and retail space, investors’ search for yield and moderate valuations could be a strong tailwind for the sector. However, this would have to overcome the traditionally defensive characteristics of the sector.

Positives for the sector:

  • Low interest rates are positive for funding, and make REITs’ traditionally high dividends more attractive to investors
  • Warehouse, data center and telecom towers are benefiting from technology and e-commerce trends
  • Single-family residential REITs segments are seeing strong demand and rising rents, which is translating into higher multi-family rents
  • Long-term demographics support recovery in extended-care and assisted-living facilities

Negatives for the sector:

  • High unemployment and expiration of the CDC eviction moratorium could lead to multi-family lease defaults
  • Long-term shift to e-commerce from brick-and-mortar stores puts retail REIT revenues at risk
  • Short-term uncertainty exists about workers returning to the office
  • Traditionally defensive characteristics in a rising market

Risks for the sector:

  • A quicker-than-expected rise in interest rates could be a sharp headwind
  • A permanent rise in work-from-home could reduce demand for office real estate

What do the ratings mean?

The sectors we analyze are from the widely recognized Global Industry Classification Standard (GICS®) groupings. After a review of risks and opportunities, we give each stock sector one of the following ratings:

  • Outperform: likely to perform better than the broader stock market*
  • Underperform: likely to perform worse than the broader stock market*
  • Neutral: no current view on likely relative performance

 

* As represented by the S&P 500 index

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Communication Services Health Care
Consumer Discretionary Industrials
Consumer Staples Information Technology
Energy Materials
Financials Utilities

 

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