Soaring interest rates and the weakening economy have crushed real estate investment trusts in 2022, with the FTSE Nareit All Equity REIT index dropping 23% year to date.
Rising rates hurt REITs because they borrow money to buy properties and because higher yields make bonds, which generally are safer investments, more attractive compared with REITs.
Meanwhile, a slumping economy lessens demand for real estate.
But the REIT declines could turn around as soon 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.
Apartment REITs
Elevated home prices and exploding mortgage rates have made owning a home unaffordable for many of us. That means strong demand for multifamily housing.
The biggest apartment REIT is AvalonBay Communities (AVB).
The company “owns and operates high-quality multifamily buildings in urban and suburban coastal markets with demographics that allow AvalonBay to maintain high occupancies and drive strong rent growth,” Morningstar analyst Kevin Brown wrote in a commentary.
Those areas are New England, New York/New Jersey, the Mid-Atlantic, Southern California, Northern California, and Seattle.
“These markets exhibit traits that create strong demand for apartments, like job growth, income growth, decreasing homeownership rates, high relative cost of single-family housing, and attractive urban centers that draw younger people,” Brown said.
He puts fair value for the stock at $250, 48% above its recent price of $169. It yields 3.75%.
Industrial REITs
The explosion of e-commerce in recent years has increased the importance of warehouses and distribution centers, which make up much of industrial REIT holdings.
Warehouse/distribution-center owners went on a building binge during the pandemic, when internet commerce soared. Now that online purchases have slowed, the warehouse sector has excess supply.
But internet buying has plenty of room for growth. E-commerce made up only 14.8% of retail sales in the third quarter. That total will undoubtedly climb in coming years.
The biggest industrial REIT is Prologis (PLD).
“The company continues to benefit from the historically low vacancy rate environment in industrial real estate,” Morningstar analyst Suryansh Sharma wrote in a commentary. “The market for industrial real estate continues to be strong.”
To be sure, “we are seeing some signs of moderation,” he said. “We believe that weaker macroeconomic conditions, slower adoption of e-commerce, and a strong supply pipeline will result in the normalization of occupancy levels and market rent growth … in upcoming years.”
Sharma puts fair value for the stock at $118, 1.7% above its recent price of $116. It yields 2.72%
Data Center REITs
Data usage is mushrooming, with much of it taking place in the cloud. That requires boatloads of computer and telecommunications equipment, which is stored in data centers. The need for data should only increase, putting this REIT sector in good stead.
The biggest data-center REIT is Equinix (EQIX).
The company “exceeded our sales and profit expectations in the third quarter and indicated that its business has remained strong, implying solid results should continue at least into next year,” Morningstar analyst Matthew Dolgin wrote in a commentary.
“Management didn’t dismiss the potential effect of a weak macroeconomic environment, but the firm is showing no signs yet, leading us to believe the secular move toward cloud providers and interconnected data centers is uninterrupted.”
To be sure, Dolgin thinks the stock is currently overvalued. He puts fair value at $570, 15% below its recent price of $673. It yields 1.83%.
Cellphone Tower REITs
Cellphone usage continues to soar, with people utilizing their mobile devices for everything from watching TV to buying airline tickets.
For mobile phones to work -- everyone hates those dropped/interrupted calls -- telecom carriers such as Verizon, AT&T and T-Mobile need to have antennas on cellphone towers. So the owners of those towers are in the catbird seat, charging the carriers rent.
The biggest owner of cellphone towers is American Tower (AMT).
“We think American Tower's strategy to diversify its tower portfolio globally leaves it best positioned among the three U.S. tower companies, as it is primed to benefit from the continually increasing demand in mobile data worldwide,” Dolgin wrote.
“However, we don't think veering into the data-center business, which it did with its acquisition of CoreSite, will pay off, and it distracts from the tower focus we liked for American Tower.”
Dolgin puts fair value for 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 shares of AvalonBay Communities, Prologis, Equinix and American Tower.
