When interest rates fall, many investors turn to real estate mutual funds (REITs) because of their higher yields and stable payouts. But after the global health crisis, this general rule does not apply.
Commercial real estate markets in major economies are under pressure as buildings that once housed restaurants, shopping centers and offices have become quiet. In an environment where tenants struggle to pay their rent, buying REITs for their high yields is a risky bet.
Hurt by evolving business needs in the post-pandemic environment, the S&P 500 REIT Index underperforms the broader market. While the REIT has recovered from the dip in March and is up 5% this year, the REIT's are still down 7% and are becoming one of the worst performers this year.
According to S&P Global Ratings, retail landlords will face their tenants' financial hardship until at least 2021 as companies delay rent payments and some seek bankruptcy protections.
"We expect a bumpy road to recovery for retail REITs, as lease deferments, the risk of write-offs and the accelerated pace of store closings will affect the recovery outlook for retail landlords," the report said.
"As a result, we think credit statistics will not return to pre-pandemic levels until 2022."
S&P has a negative outlook for 29% of North American retail REITs, up from 10% in December. Retail REITs with higher exposure to essential businesses, such as supermarkets and banks, have had better luck collecting rent than those with more nonessential and distressed tenants, according to the report.
For example, Simon Property Group Inc (NYSE :), the largest shopping center operator in the US, has seen its inventory fall by about 60% this year as stores struggled to pay the rent with bankruptcy filing.
Winning Bets
But amid these shifting trends, which have hurt a large number of REITs, some winners are emerging. Although the pandemic has forced malls, restaurants and offices to close and employees to work remotely, it has accelerated the shift to online shopping.
This trend is fueling the demand for warehouses and fulfillment centers. Prologis (NYSE 🙂 and Duke Realty (NYSE :), industrial real estate mutual funds that own and operate warehouses, are both trading at their highest levels since the start of the financial crisis.
These stocks provide good diversification for investors within the sector. They also offer a way to bet on the future of retail, as their warehouses are the lifeblood of online giant Amazon (NASDAQ 🙂 and popular brands like Home Depot (NYSE 🙂 and Wayfair (NYSE :).
In July, Prologis reported strongly, showing that the pandemic-induced shift in shopping habits is helping the San Francisco-based warehouse manager. Core Funds from Operations (FFO) per share increased to $ 1.11 versus $ 0.77 in the second quarter of 2019.
"While e-commerce is clearly tailwind, demand is broad across several categories – a trend we saw accelerating in June," Hamid Moghadam, Prologis CEO, said in a statement.
Prologis stock is up 16% so far this year, closing at $ 103.65 yesterday, while the shares of Duke Realty, an Indianapolis-based warehouse and distribution business operator, are up about 11% over that period. They were at $ 38.47 at the closing bell Tuesday. The latest report showed a slight increase in revenues.
Bottom Line
Even with today's extremely low interest rates, investing in REITs targeting office and residential markets still involves many risks. But changing shopping and working patterns are increasing the value of REITs serving e-commerce giants, creating new opportunities for investors looking for higher returns.
