REITs Surge On Merger Mania

February 19, 2020

Real Estate stocks led U.S. equity markets to fresh record highs this week, shaking off coronavirus-related losses amid a frenetic slate of corporate earnings and M&A news.

Adding on to its impressive 3.2% gains in the prior week, the S&P 500 finished higher by another 1.6% while the Dow Jones Industrial Average added nearly 300 points.

REITs delivered their best week in more than a year, jumping 4.2% as earnings results continue to top estimates and the M&A animal spirits come alive.

Cell Tower REITs surged more than 10% after Sprint and T-Mobile reached a merger deal. Meanwhile, Simon Property plans to buy Taubman Centers, further consolidating Class-A mall ownership.

Residential REITs, homebuilders, and housing-related companies continue to lead the charge in 2020, delivering strong earnings this week as the U.S. housing market has come back to life.

This idea was discussed in more depth with members of my private investing community, iREIT on Alpha.

Real Estate Weekly Outlook
The animal spirits are alive and well. A frenetic slate of corporate earnings and M&A news was exactly what the doctor ordered to restore harmony – and record highs – to the U.S. financial markets following a two-week panic over the coronavirus outbreak. While the global economic impact of the outbreak remains unclear – particularly in the fragile Asian and European economies – the U.S. consumer has yet to blink, reflected in resilient domestic economic data and solid corporate earnings. For now, the Goldilocks conditions of low interest rates and domestic-led economic growth have provided ideal conditions for residential and commercial real estate fundamentals, which was on full-display during peak real estate earnings season this week.

(Hoya Capital, Co-Produced with Brad Thomas through iREIT on Alpha)

Adding on to its impressive 3.2% gains in the prior week, the S&P 500 ETF (SPY) finished higher by another 1.6% while the Dow Jones Industrial Average (DIA) added nearly 300 points, bringing its two-week gain above 1,100 points. The 10-Year Treasury Yield (IEF) added one basis point to close at 1.59%, still within shouting distance of its 2016-low. The story this week, however, was the 4.2% surge from the broad-based commercial Real Estate ETF (VNQ), which was its best week in more than a year and the fifth-best week over the past decade, led by cell tower REITs, which surged more than 10% after Sprint (NYSE:S) and T-Mobile (NASDAQ:TMUS) reached a merger deal.

The Hoya Capital Housing Index, the benchmark that tracks the performance of the U.S. residential real estate sector, was higher by 2.3% this week, also closing at all-time highs. Redfin (RDFN) jumped nearly 25% after the tech-focused broker reported an 88% jump in revenue, powered by increased housing market activity in late 2019. Residential mortgage REIT Chimera (CIM) jumped 5% after reporting strong results, citing a “sound underlying fundamentals of the U.S. economy: low unemployment, attractive mortgage rates, and a lack of housing supply.” Residential flooring supplier Mohawk (MHK) gained nearly 4% after reporting better-than-expected results, citing “positive trends in housing that should be a tailwind” for 2020.

The Commercial Real Estate (VNQ) sector regained its YTD outperformance this week after falling behind the major average earlier this month. REITs are now higher by 7.3% YTD gains compared to the 4.9% gains from the S&P 500. The technology, utilities, and real estate sectors remain the top performers so far in 2020 while the energy sector is lower by nearly 10%. As discussed in our recent 2019 Real Estate Recap, REITs delivered their second-best year of the decade in 2019, delivering a total return of nearly 29%, closely behind the 31% gains from the S&P 500.

Real Estate Earnings Check-Up
It was a lively week of earnings and REIT-related news with more than 30 REITs and residential real estate companies reporting results. As discussed in our recently published Real Estate Earnings Preview, earnings season will remain in high-gear next week with another 40 REITs reporting results. Below we compiled the notable earnings that we’re watching across the residential and commercial real estate sectors.

Apartment REIT UDR Inc. (UDR) reported results on Tuesday, forecasting a strong 2020 NOI growth rate of 3.4% at the midpoint and occupancy of 97%. As discussed in Renter Nation Is Alive And Well, apartment REITs reported strong 4Q19 results as rent growth reaccelerated in 2019, powered by robust employment and wage gains. Millennial-led gains in the homeownership rate did not come at the expense of the rental markets. Apartment occupancy rates remain near record highs, while turnover rates dipped to new record lows. For the major seven apartment REITs, same-store operating metrics were stellar across the board, as NOI growth jumped 3.9% in 4Q19, the strongest rate of growth since 2016.

Merger mania was the theme across the rest of the commercial REIT sector, however. Mall REIT stalwart Simon Property (SPG) announced plans to acquire fellow mall REIT Taubman Centers (TCO.PK) for roughly $3.6B in cash. Taubman, which owns a relatively high-quality portfolio of Class A malls, jumped more than 50% on the week, pushing its gains this month to roughly 100% while Simon finished lower by 2% on the week. The merger news didn’t do much to stop the bleeding for the lower-productivity mall REITs, however. CBL & Associates (CBL) and Washington Prime (WPG) dipped another 14% and 9%, respectively, on the week, extending their sharp YTD losses.

Merger madness continued in the tech REIT space as data center REIT CyrusOne (CONE) reportedly retained Morgan Stanley after receiving M&A interest in a deal that could involve Blackstone, KKR or Stonepeak. Not to be outdone, however, cell tower REITs were the focus after the U.S. District Court approved the $26B merger between Sprint and T-Mobile, opining that the deal is unlikely to weaken competition in the U.S. wireless market. Cell tower REITs American Tower (AMT), Crown Castle (CCI), and SBA Communications (SBAC) were each higher by more than 7% on the week. Staying in the tech space, data center REIT Digital Realty (DLR.PK) rose nearly 7% on the week after reporting better-than-expected results yesterday afternoon as the closely-watched net bookings metric came in at a solid $69M in 4Q, matching the strong 3Q rate. We’ll publish our updated Data Center REIT report next week after CyrusOne and QTS (QTS) report.
data center leasing

The M&A news didn’t end there. Public Storage (PSA) gained more than 3% on the week on reports that it is exploring an acquisition of Australian self-storage operator National Storage REIT [ASX:NSR], not to be confused with National Storage Affiliates (NSA), which nonetheless jumped more than 10% on the week. Staying in the storage sector, business storage REIT Iron Mountain (IRM) was also higher by nearly 5% after beating on 4Q FFO and forecasting 2020 guidance above estimates. Stay tuned for another busy week of commercial and residential real estate earnings ahead.

Real Estate Economic Data
Below, we analyze the most important macroeconomic data points over the last week affecting the residential and commercial real estate marketplace.

Retail Sales Rise in January
The generally positive holiday season momentum continued into January for retailers, according to Retail Sales data from the US Census Bureau. Total retail sales rose 0.3% in January from the prior month, squarely in line with expectations, led by a recovery in the housing-related retail segments. On a seasonally-adjusted year-over-year basis, brick and mortar sales were higher by 2.3% in December while e-commerce sales jumped 8.9%. In 2019, brick and mortar recorded a 2.1% gain and e-commerce recorded a 12.9% jump, amounting to a total rise in retail sales for 2019 of 3.6%.

Seven of the ten brick and mortar segments recorded a positive month in January. The strongest retail segments in the January report were the Miscellaneous, Building Materials/Garden, Food Service, and Furniture segments. Clothing sales were particularly weak in January, dipping by 3.1% month-over-month after adjusting for the holiday shopping patterns. Department stores actually recorded positive growth in January, but remain the weakest category on a year-over-year basis at -5.5%.

Inflation Remains Cool, Except For Housing Costs
Inflationary pressures remain muted, according to the latest CPI report released this week from the Bureau of Labor Statistics. Housing costs continue to be the primary driver of what little overall inflation that there is. Housing (CPI: Shelter) accounts for more than a third of the total CPI weight (42% including housing-related services), and since 2013, housing inflation has been significantly above the overall inflation rate. Primary rents remain higher by 3.8% from last year, the highest since last September, while Owner Equivalent Rents (OERs) are higher by 3.3%. The overall CPI Shelter index is higher by 3.3% year-over-year and has been above 3% since April 2014. Core CPI excluding housing is higher by just 1.50% on a year-over-year basis, continuing a deceleration from its recent peak of 1.69% last August.

2020 Performance Check-Up
Following a nearly identical pattern to 2019, Cell Tower REITs have topped the charts so far in the REIT sector in 2020, followed by data center, industrial, and billboard REITs while retail REITs continue to lag. As discussed above, the broad-based commercial real estate indexes are higher by roughly 7.5% compared to the 4.9% gains from the S&P 500. Homebuilders have picked up where they left off in 2019 with gains of 18% so far this year following gains of nearly 50% last year. At 1.59%, the 10-year Treasury Yield has retreated by 33 basis points since the start of the year and is roughly 170 basis points below peak levels of 2018 of 3.25%.

On Monday, we published The Taxman Cometh: REIT Tax Myths. With tax season (unfortunately) upon us, we address some of the most common questions and respond to some of the outright myths that we hear related to REITs and taxes. REIT investors were big winners from recent tax reform. Functionally, from a tax reporting perspective, an investor’s experience with REITs shouldn’t be any different than a typical dividend-paying stock. REITs report using the standard 1099-DIV, not a K-1. For REITs, dividend distributions for tax purposes are heavily weighted to ordinary income – the majority of which qualifies for a 20% Qualified Business Income (QBI) deduction – with the balance coming from capital gains and return of capital, each of which are typically taxed at lower rates.

REITs taxes
Last week, we published VNQ: A David Vs. Goliath Story. Our ETF Spotlight Series has taken us across the fund landscape from High Yield REIT ETFs and CEFs to newer innovative funds offering a more growth-oriented approach to real estate. The plain-vanilla “Core REIT” ETFs still rule the day from an AUM perspective, however, led by Goliath VNQ. “Core REIT” ETFs are distinguished by their market capitalization weighting system, exposure across most equity REIT property sectors, and ultra-low expense ratio – which averages roughly 20 basis points – a fraction of the typical actively-managed mutual fund or CEF. We took a look at the property sector breakdown of these six funds.

Last week, we also published Real Estate CEFs: Satisfying A High Yield Fix. We examined the most popular CEFs with an average dividend yield of 7.0%. While we believe ETFs are the more suitable option for the vast majority of investors, CEFs can make sense for certain investors seeking access to leverage, active management, and are willing to pay a steep expense premium for it. For investors who absolutely need the 6-7% yield from their real estate allocation, we like the Cohen & Steers suite of levered CEFs: RQI and RNP and believe that these may indeed be slightly better options for sophisticated investors than the high-yield REIT ETFs covered in the last report, especially for tax-advantaged accounts that wouldn’t benefit quite as much from the substantially superior tax efficiencies of ETFs.

Next Week’s Economic Calendar
A busy two-week stretch of housing data begins on Tuesday with Homebuilder Sentiment, follows on Wednesday with Housing Starts and Building Permits and concludes on Friday with Existing Home Sales.

If you enjoyed this report, be sure to “Follow” our page to stay up to date on the latest developments in the housing and commercial real estate sectors. For an in-depth analysis of all real estate sectors, be sure to check out all of our quarterly reports: Apartments, Homebuilders, Student Housing, Single-Family Rentals, Manufactured Housing, Cell Towers, Healthcare, Industrial, Data Center, Malls, Net Lease, Shopping Centers, Hotels, Billboards, Office, Storage, Timber, and Real Estate Crowdfunding.

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