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Key takeaways:
Overview:
Though often perceived as a defensive sector, REITs were among the hardest hit segments and underperformed the broader market in the recent market selloffs. The impact of social distancing measures on the retail sector, a potential rise in unemployment and slowing wage growth are factors likely weighing on real estate fundamentals, despite ultra-low borrowing rates.
Source: Bloomberg, as of 3/23/2020.
Index performance is for illustrative purposes only. Index performance does not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.
Going forward, despite the recent volatility, several factors may continue to support strength in the real estate market:
Source: Bloomberg, as of 3/26/2020.
Notes: The household debt service ratio is the ratio of total required household debt payments to total disposable income.
However, there are several noteworthy risks to the REIT market that investors should monitor. These include:
Source: MSCI, JP Morgan, BlackRock, as of 3/23/2019.
Index performance is for illustrative purposes only. Index performance does not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.
Notes: Cyclicals vs. defensives is represented by the ratio between the MSCI USA Cyclical Sectors vs. MSCI USA Defensive Sectors Indexes. The Global Manufacturing PMI is produced by JP Morgan.
Mortgage REITs in particular have suffered in the past month, plunging nearly 60%.2
Unlike traditional REITs, which own or operate underlying properties like residential (apartments etc.), commercial (offices), retail (shopping malls), and specialized REITs (cell towers, infrastructure, gaming etc.), mortgage REITs’ primary business is to provide financing for income-producing real estate by purchasing or originating mortgages and mortgage-backed securities (MBS) and earning income from the interest on these investments.
As a result, mortgage REITs are sensitive to interest rates and the shape of the Treasury yield curve. While mortgage rates are falling, funding costs have risen; that combination is hurting the mortgage companies. It is important to note that they are currently included within financials from a GICS sector breakout perspective due to the unique nature of their business models.
Source: Bloomberg, as of 3/23/2019
Investor positioning in REIT ETFs is high relative to other cyclical assets. Over the last twelve months, REIT-focused U.S. listed ETFs gathered $6.3 billion flows (figure 5). This positioning decelerated in recent months, but remains quite bullish compared to other sectors.
Source: Markit, BlackRock, as of 3/23/2020.
Conclusion:
From an investment standpoint, the domestic focus of U.S. residential REITs may provide investors with some insulation from challenging international market conditions such as weak growth in both emerging and developed markets outside the U.S. Coupled with REITs interest rate sensitivity, a regime of low interest rates could provide a tailwind for REITs. However, deterioration in consumer sentiment, shift in consumer sentiment, and a credit crunch all are potential risks that bear watching.
Grant Dechert and Jasmine Fan contributed to this article.