Investor appetite for REITs has declined with the COVID-19 pandemic and unlike the broader stock market, the asset class has yet to approach pre-COVID levels. While various sectors of the real estate industry face divergent outlooks, it is worth remembering the evolution of REITs and the long-term benefits of having them in a diversified portfolio. Among US REITs, certain sectors/sub-sectors look poised to benefit from a recovery. From a portfolio perspective, real estate offers meaningful diversification and income generation benefits with US REITs tending to play a “hybrid” role between equities and bonds.
In the first half of 2020 and most significantly in March and April, the negative effects of the global pandemic began to manifest within the real estate industry. In the first quarter, US Real Estate Investment Trusts (REITs) declined by 28% although in the following period they rebounded by 10.8%. The retail, hospitality and food services industries especially remained under extreme duress as lockdowns resulted in the closure of many businesses and rising unemployment and social distancing guidelines dented demand. As many small businesses have put up the shutters for good and a good number of them have closed down temporarily, investors have rightly become concerned about rent and mortgage payments. This combined with an ever-growing shift in consumer demand from traditional brick-and-mortar stores to online shopping has raised pertinent questions regarding the nature of cash flows and dividends for US REITs in 2020 and beyond.
Opportunities Within a Shifting Landscape
By the second quarter of 2020, policy makers responded with massive, broad-based fiscal and monetary stimulus to support affected workers and businesses in record time. Economic data for May showed that these interventions helped mitigate the negative effects of the steep economic decline. This proved to be beneficial for US REITs as well with many sectors recording gains and the severely affected ones, such as regional malls and shopping centers, coming off their lows.
Among sectors, Industrials appears to have weathered the crisis better than others and continues to benefit from the economic recovery and the rise in e-commerce. Although office space and apartments have been affected, companies are continuing to adjust their operational needs and renters are expected to continue to seek out places to live as the disruption passes.
From a historical perspective, REITs could be considered as much more diversified today than ten years ago. Also, evolution wise, what we choose to call here as “focused” REITs (cell towers, data/distribution centers and eldercare facilities)1 along with the Residential, Industrial and Diversified sectors have expanded at the expense of the Retail, Office and Hotel & Resort sectors. This also means that the broad array of companies now available as part of REITs generates a more diversified stream of income for investors than before (Figure 1).