06/02/2016 | by Sarah Borchersen-Keto

REITs outpaced the broader market in May, as near-term fundamentals remain positive and capital continues to flow into the sector, analysts said.

The FTSE/NAREIT All REIT Index had a total return of 2.3 percent in May, while the S&P 500 Index gained 1.8 percent. For the year to May 31, the total return of the FTSE/NAREIT All REIT Index was 6.5 percent, while the S&P 500 Index posted a total return of 3.6 percent. The yield on the 10-year Treasury note fell 0.4 percent during the first five months of the year.

With a few exceptions, “you really had a pretty solid sector-by-sector modest uptick for the month across the board,” said Jeffrey Langbaum, senior REIT analyst at Bloomberg Intelligence. He noted that REIT first quarter earnings were “fairly consistent” overall.

Haendel St. Juste, a managing director at Mizuho Americas Research, said REITs’ first quarter earnings season produced “pretty good messaging” from management. REIT executives “reminded folks that we are still mid-to-late cycle, with generally good pricing power,” according to St. Juste.

St. Juste also stressed the importance of stock picking in the current market. “It’s becoming increasingly important to be selective,” he said, because “performance is all over the board.”

While the possibility of higher interest rates is still on investors’ minds, analysts said concerns seem to have receded.

“The REIT group’s positive run year-to-date suggests, perhaps, that expectations of modest rate hikes are priced in,” Langbaum said. He pointed out that two REIT segments that are particularly interest rate-sensitive, health care and single-tenant net lease, have had solid returns so far in 2016. Health care REIT returns for the year to May 31 were 6.4 percent. Single-tenant net lease REIT returns were 17 percent in the same period.

“Perhaps that suggests that the market doesn’t expect significant rate hikes or has started to price that in and has gotten comfortable with what the Fed is going to do,” Langbaum said.

St. Juste pointed out that supply issues, particularly for health care REITs and multifamily REITs, appear to be a more pressing concern than interest rates at this time. Concerns around layoffs at financial services firms and the impact on markets such as Seattle, San Francisco and New York have also emerged, he said.

More M&A?

St. Juste observed that the real estate cycle has reached a point where REIT mergers and acquisitions might make sense for more companies. According to St. Juste, “divergences between the haves and have-nots”—in terms of REITs’ balance sheets, pricing power and portfolio strength—are becoming more apparent.

Furthermore, private capital interest in the REIT sector and the lack of apparent succession plans at certain REITs would suggest this is an optimal time for M&A, St. Juste said. Among the top REIT performers in May were single-family home REITs, with returns of 13.9 percent.  Data center REITs produced total returns of 8.9 percent in May, and industrial REITs posted returns of 6.0 percent.