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Market Extra: Will U.S. REITs beat the S&P 500 next year?

Equity real-estate investment trusts in the U.S. may beat the S&P 500 index again next year, according to Wells Fargo & Co.  

The MSCI US REIT Index, which tracks equity REITs with a stake in properties that span the office, residential, retail, industrial, hotels and resorts landscape, has soared around 32% this year, according to FactSet data. That surpasses gains of about 25% for the S&P 500 so far in 2021, the data show.

“We can see a scenario where a low- to-mid-single-digit dividend yield for REITs overall can add to mid-single-digit earnings growth expectations for the sector, providing a fairly visible path to a high-single-digit total return profile for REITs overall in 2022,” Wells Fargo equity analysts wrote, in a Dec. 14 research report.

The resumption of leisure and business travel, “even if gradual,” along with a return to the office that may still be partial, could help drive performance of hotel and office REITs, according to the report.

Office building occupancy was 39.8% for this week, according to Kastle’s 10-city average occupancy tracker, but up from less than 10% in some big cities during the early part of the pandemic.

“Robust” consumer spending trends should support retailer leasing activity and result in a pick-up in occupancy, while industrial demand should remain high on the shift to e-commerce and re-stocking of inventories, the Wells Fargo analysts said.

“While we believe supply will increase in 2022, the backlog of demand should continue to move rents higher,” they wrote. Within industrial REITs, the analysts said their “top ideas” include “overweight-rated” Prologis Inc.
PLD,
+2.41%
,
Rexford Industrial Realty Inc.
REXR,
+2.64%

and STAG Industrial Inc.
STAG,
+1.02%

 

“Retail REITs are still recovering from the pandemic, with occupancy levels below prior peaks and bad debt elevated,” said the Wells Fargo analysts. “However, we believe that 2022 is poised for an above-average organic growth year as bad debt is significantly reduced, recently signed leases commence occupancy, rent spreads are healthy, and leasing momentum continues.”

Greg Kuhl, a portfolio manager at Janus Henderson who focuses on global property equities, told MarketWatch in a phone interview Wednesday that he also expects U.S. REIT returns may broadly beat the U.S. stock market, as measured by the S&P 500 index
SPX,
+1.63%

in 2022. 

Read: ‘Proceed with caution’: here’s what Wall Street analysts see for the U.S. stock market in 2022

Taking a wider view of performance in the pandemic, Kuhl said that U.S. REITs have lagged stock-market gains since the beginning of 2020. That’s partly because of investor concern in the early stages of the pandemic that properties wouldn’t be able to access debt markets, he said, as well as worries that commercial real estate landlords would struggle to collect rent.

“The sector sold off really heavily and the rationale sort of didn’t play out,” said Kuhl, adding that in many cases deferred rent has been largely repaid.

MSCI US REIT Index has risen around 20% over the past two years, compared with a gain of about 46% for the S&P 500 over the same period, according to FactSet data.

“This year was sort of a ‘rising tide lift all boats’ type of market for REITs in the U.S.,” with the reopening trade in the pandemic helping to drive gains, said Kuhl. “We’re now into a situation where the fundamentals going forward are going to be really important.”

In 2022, Kuhl expects to see “disparate cash flow growth for different parts of the real estate market.” Industrial warehouses are an area of strong demand that could see cash flow growth in the “low to mid-teens,” he said, adding that in some cases space is being leased “before shovels are in the ground.”

Meanwhile, business travel could pick up next year, potentially benefiting hotels, according to Kuhl. By contrast, leisure travel already has seen a strong increase in the pandemic, he said.

Overall, U.S. REITs could produce total returns in 2022 that are in the upper single-digits, if not higher, Kuhl estimates. By comparison, Wells Fargo’s equity strategy team expects “relatively flattish returns” for the S&P 500 in 2022, according to the bank’s Dec. 14 research note on the outlook for real-estate securities.

“To the extent people are concerned about inflation, this is one of the best asset classes that can hedge against that,” Kuhl said of REITs. “So there are some things that really work in its favor from that perspective, too.”

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