U.S. Equity REITs: Step Away Completely?

packs-163497_1280.jpgThe 2016 financial market is certain to continue to be plagued by volatility. Due to poor prospects in the world economy, particularly in China and other emerging markets, most investors seem to be overwhelmed. I’m not saying that a strong deceleration in China is certain to bring developed economies down with it, but it may act as a catalyst for a substantial change in perception. I was interested to learn that a week ago the Royal Bank of Scotland (RBS) strongly encouraged clients to step away from the equity markets completely and suggested that they invest in high quality bonds.

There’s no denying that 2015 was volatile, largely due to investors being overwhelmed by managing both potential domestic and overseas risks. When the Fed threatened to raise interest rates, the market would sell off. In fact, the number of sell off attempts was so high that day that the Fed had no choice but to announce the interest rate hike was a nonevent day. With the Feds clearing the path, investors have shifted their focus overseas, primarily on China.

Due to equity REIT stocks appearing to correlate with the financial market’s ups and downs, REIT share prices have been significantly impacted. Apart from lodging REITs, I can’t recall a time in 2015 when a selloff in equity REITs wasn’t associated with a major selloff in the market. What had been a major benefit of REITs (not to be compared with S&P 500) appears to no longer be the case (at least for the moment). It could be said that the ascension of REITs to mainstream has resulted in the asset class becoming more vulnerable to market swings.

There are several ways to handle this situation. The first option is to follow RBS’s advice and get out of the equity market. In this case, there will be no changes to your investments, either negatively or positively. Some people would say it’s important to hold on to cash, something I would do if I knew the world was falling apart. This may be the case when fundamentals are deteriorating and growth prospects are decreasing. People may disagree on the pacing, but the U.S. economy continues to grow to the point that I would shocked if it fell into a recession in 2016.

The second option is to take the bull by the horns and try to determine what has and has not been working for equity REITs. This is frustrating because REITs, as operational companies, have performed well.

Investing in REITs in aggregate as an asset class simply didn’t work in 2015, something I attribute to their bad reputation during interest rate hikes. Although some authors have extensively proven that REITs aren’t destined to tank during periods of interest rate hikes, the market still assumes this is the general rule. Throughout 2015, I constantly read over the financial websites that called for abandoning dividend stocks, including REITs. I don’t see this changing in 2016, which is why I would not invest in broad REITs indexes or ETFs in 2016.

On the other hand, sectors whose fundamentals remained resilient and have promoted strong growth rates, such as apartments, data centers, and self-storage, went through 2015 with positive returns. In addition, free standing retail, which includes net lease companies, also had good share price performance. In 2015, picking sectors was a smart move. In 2016, this should continue to be the case.

Disclaimer: This newsletter is not engaged in rendering tax, accounting, or other professional advice through this publication. No statement in this issue is to be construed as a recommendation to buy or sell any security or other investment. Please do your own due diligence before making any investment decision. Some information presented in this publication has been obtained from third-party sources considered to be reliable. Sources are not required to make representations as to the accuracy of the information, however, and consequently the publisher cannot guarantee accuracy.

Disclosure: The author has no positions in any shares mentioned, and no plans to initiate any positions within the next 72 hours.

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