US real estate investment trusts (REITs) have delivered solid outperformance since the start of the US trade war with China. Domestic REITs, as represented by the FTSE NAREIT All Equity REITs Index, generated a total return of 32.4% from March 1, 2018 to August 16, 2019, which was a relatively volatile period for the capital markets given the geopolitical overhang. By comparison, equities in general have been more challenged in terms of generating total returns during this period, as shown in the chart below.
New dynamics in the geopolitical and macroeconomic environment have allowed the real estate asset class to stand out from the pack. With market volatility making investors more cautious, the stable and predictable cash flows of REITs, coupled with their reliable income distributions, have enhanced appeal to investors.
Figure 1: Performance of REITs Since the Start of the Trade War (%)
March 1, 2018 to August 16, 2019
A more challenging macroeconomic environment shifted market leadership to REITs
Since the start of the US trade war with China 18 months ago, a convergence of factors has helped push US REITs higher. As investors have fretted over the impact of tariffs and potential currency implications on corporate cash flows and earnings, US REITs have been a relative “safe-haven.”* Unlike many other equity sectors, US REITs generate the vast majority of their revenues and earnings from domestic sources. This has helped insulate the sector from the impact of the trade war and currency dispute with China. REITs own long-lived, high-value physical assets that they often lease out to tenants for multi-year periods. The rent collected from these contractually obligated tenants represents a robust stream of cash flow.
Falling interest rates are a potential benefit to REITs
More than a dozen central banks around the world cut interest rates in the second quarter of 2019, and the Federal Reserve joined them by cutting the Fed Funds rate in July for the first time since 2008. The yield on the 10-year Treasury note dropped from 2.68% at the end of last year to 1.55% in mid-August.2 Many sectors may benefit broadly from low and falling interest rates, but lower rates can be particularly beneficial to REITs. REITs must distribute at least 90% of their taxable income to existing shareholders each year to maintain their tax-advantaged status. This means they cannot stockpile cash on the balance sheet as other companies can, and often must rely on outside capital to fund growth. As interest rates fall, the cost of borrowing typically falls as well.
Additionally, REITs may offer healthy dividend streams that can become more attractive to investors as rates fall and they are faced with lower yields on many fixed income alternatives.
Considering the overhangs of the US trade war and currency dispute with China, we believe investors seeking to position their portfolios more defensively may want to consider US REITs. The asset class can be relatively insulated from these geopolitical risks because of its limited exposure to non-US revenues. REITs may potentially benefit from lower interest rates as the world enters another cycle of monetary easing. Finally, the US REIT asset class can offer attractive yields and differentiated return characteristics in a challenging macroeconomic environment.
About Invesco Real Estate. Invesco Real Estate has more than 500 employees in 21 different markets worldwide with a focus on US real estate, global real estate, global real estate income, infrastructure and master limited partnerships.
2. Bloomberg as of 8/16/2019
3. Bloomberg as of 8/16/2019
Blog header image: Nemanja Glumac / Stocksy
*A safe-haven is an investment that may retain or increase in value during market downturns.
The FTSE NAREIT All Equity REITs Index is a free-float adjusted, market capitalization-weighted index of US equity REITs.
The MSCI World Index is designed to measure the equity market performance of developed markets and includes the US, Eurozone area, Japan and Canada.
The S&P 500 Index is a capitalization-weighted index of 500 stocks intended to be a representative sample of leading companies in leading industries within the US economy. Index performance includes reinvestment of dividends but does not include fees, expenses, or taxes.
Investments in real estate related instruments may be affected by economic, legal, or environmental factors that affect property values, rents or occupancies of real estate. Real estate companies, including REITs or similar structures, tend to be small and mid-cap companies and their shares may be more volatile and less liquid.
The opinions expressed are those of the author, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.
Invesco Distributors, Inc. is the US distributor for Invesco Ltd.’s retail products and collective trust funds, and is an indirect, wholly owned subsidiary of Invesco Ltd.