05/02/2014 | By Sarah Borchersen-Keto
REITs showed renewed vigor in April as the FTSE NAREIT All REITs Index posted a total return of 2.9 percent and outpaced the 0.7 percent return for the S&P 500 Index. April’s advances were an improvement on the 0.3 percent return that REITs had in March.
REIT advances in April followed a solid showing in the first quarter of 2014, when gains for the FTSE NAREIT All REITs Index stood at 8.6 percent.
Paul Morgan, managing director of equity research at MLV & Co., characterized the REIT market’s performance for both the month and year as “strong.” With REIT earnings season about midway through, “I think we’ve avoided the disappointments that can cause a hiccup in the market,” he added.
Analysts pointed to continued improvement in fundamentals to explain the industry’s performance.
“From a fundamental standpoint, there are several positives. Occupancy across several subsectors is trending up and, in some sectors at least, is at peakish levels, which bodes well for rent growth,” said Vikram Malhotra, analyst at Morgan Stanley.
Malhotra added that at the same time, supply levels remain constrained: “It’s a favorable demand-supply dynamic. We’re not really seeing increased construction levels across any subsector apart from industrials, but that’s really just at the margins.”
“Even though we’re not seeing robust growth on the demand side, broadly speaking, it’s amplified by the lack of new supply, and that should continue,” Morgan noted.
Meanwhile, favorable interest rates continue to play a role in supporting REIT fundamentals, analysts said. Morgan noted that interest rates have remained steady so far in 2014, which is “in contrast to what a lot of people had really feared for the year.”
While concerns over rising interest rates have not gone away, the attitude now appears to be that “maybe the fears have been overly discounted into the valuations,” Morgan said. “The reality is that maybe we’ll have a relatively measured increase in rates over the longer-term period, rather than a spike,” he said.
In first quarter earnings calls, REIT CEOs have noted that low interest rates are producing lower capitalization rates, which, in turn, are boosting valuation levels.
A Healthy Month
Turning to specific segments of the REIT market, the biggest gains during April were seen in the health care sector, where total returns rose 6.8 percent during the month. Health care is particularly sensitive to interest rates due to the long-term leases prevalent in the segment, analysts said.
The triple-net lease segment also benefitted from the low interest rates seen in April, according to Malhotra, who added that he expects the strong institutional interest in triple-nets witnessed during the past six months to continue.