The Case for Why REITs Will Continue to Do Well

If an equity investment had a super 2021, then you’d think next year wouldn’t be so spectacular, right? After all, there are projections galore that the stock market won’t be as great in 2022. Well, one segment is going to keep on performing superbly, according to BCA Research.

That would be equity real estate investment trusts (REITs), those portfolios of properties that pay nice dividends—averaging 2.8% annually, versus 1.3% for the S&P 500—gleaned from the rents they charge tenants. Thus far this year, these REITs, as embodied in the FTSE Nareit Equity index, are up a stellar 32.1%. That’s compared to the S&P 500’s 23.8%.

Tight supply in many parts of commercial property and growing rental demand should keep REITs aloft, BCA argued. The current buoyant state of REITs is in contrast to early in the pandemic, when they took a dive, and so did their earnings, called funds from operations, or FFO.

Equity REITs (that is, those excluding mortgage ones) in general are seeing FFO rise in most of their sectors, along with occupancy, with lodging an exception, BCA said in a research report. And REITs’ dependence on debt, which many have viewed as a weakness, is diminishing, with the debt-to-assets ratio reaching 49% recently, down from 58% in the financial crisis. The decline of interest rates also has been a boon to the trusts.

True, some sectors are struggling: offices, for instance, where vacancies are now 18%. But the BCA report, quoting commercial real estate company CBRE, contended that, “while the average US employee is likely to spend 24% less time in an office, demand for office space will fall by only 9%.” Reason: hybrid arrangements combining days working remotely and in the office mean that a large need for space won’t vanish.

Among the big REIT winners, data centers stand out, as demand for them surges. BCA said that since 2016, this category has outperformed the REIT benchmark by 60 percentage points.

Moderate levels of inflation and rising rates are usually a positive for REITs’ performance. However, just like equities, once inflation rises too high, REITs’ returns fall, BCA found. That’s an inflation increase of above 3.3% yearly.

The demand outlook is similarly upbeat for industrials, which these days mostly means warehouses. The industrial REITs’ occupancy rate is at an all-time high at 4 percentage points above its 20-year average, BCA figured, and it now stands at 96%. Thanks to an expected decline in globalization, the firm stated that “companies will move to re-shore some of their production to gain greater control over supply chains. This will amplify the need for industrial space.”

REITs remain no place to find diversification: Their correlation to stocks is 0.57. Still, if the trusts keep shining as much as BCA expects, then their place in portfolios is secure.