Guide to the US REITs industry
Contains a spreadsheet with data on all the REITs listed in the US
Hi there!
This week, we have prepared a special feature on the US REITs (Real Estate Investment Trusts) sector, a sector in which we have been involved (on and off) for the past 5 years and have been wanting to cover for a long time. In addition to an explanation of the sector (types of REITs, segments, how to evaluate them, current situation...), we have prepared a spreadsheet with all the companies in the United States (market cap, FFO, debt, dividend...) plus several analyses that we believe is tremendously useful for anyone interested in the sector.
The Week in the Markets
Guide to the US REIT industry
Our Portfolio Management
Week in the Markets
The S&P 500 reached new historic highs this week (it has risen in 11 out of the last 12 weeks), led by the megacaps. Nvidia, a major player in the AI revolution due to the demand for its semiconductors, stood out, rising almost 10%. This comes after the elections in Taiwan last week. Overall, it was a very good week for the Magnificent 7, which sets the U.S. indices apart from the rest of the world and highlight the Technology and Communications sectors above the rest. This is normal, as we explained in detail in a November post where we outlined the weight of the components in each sectoral index considering that the former is composed of 51% by Microsoft, Apple, and Nvidia, and the latter is 48% represented by Meta and Alphabet, all of which have risen by more than 2.5%.
One of the key factors of the week was once again the decline in expectations of rate cuts in 2024. Both in the US and Europe. In Europe, several policymakers made commentaries about interest rates. For example Lagarde took advantage of the Davos meeting to mention that she expects the first interest rate cuts to happen in the summer, those comments prompted financial markets to scale back bets on an early reduction in interest rates. Meanwhile, similar situation in the US where on Tuesday from the Federal Reserve Governor Christopher Waller, who stated during a virtual conference that "I see no reason to move as quickly or cut as rapidly as in the past" given the healthy state of the economy.
This has resulted in the futures markets now pricing only a 12.2% chance of seven or more rate cuts in 2024 (as of the close of trading on Friday), compared to 61.5% the week before. The likelihood of a rate cut in March also dropped from 81.0% to 47.2%.
This is affecting the markets significantly, particularly impacting assets most sensitive to risk, such as small caps, and another example is the Bitcoin's irregular start to the year. Similarly, by sectors, we observe that the worst performers of the week have been Real Estate and Utilities, which are the most sensitive to interest rates due to their capital structures being more dependent on debt.
As for commodities, the volatility of Natural Gas was once again evident. The Henry Hub plummeted nearly 25%, and the TTF lost over 10% of its value. In fact, as we mentioned last week, this week has been extremely cold (see gas consumption in the first image), and European inventories are already emptier than they were at this time in 2020 and 2023 (2953 BCF now vs 2988 and 3065 in 2020 and 2023 respectively). However, what matters for prices are the forecasts, and the next fortnight in the most accidental part of Europe is not very cold. Similarly, the global issues that caused the TTF to rebound at the end of the summer are resolved, and the fundamentals (as we have discussed in 2023) do not support further increases.
Regarding oil, it is being influenced by the tremendous volatility caused by tensions in the Red Sea. Houthies attacks on ships, primarily containers destined for Europe, have led to significant disruptions. The fear is that if a tanker is set on fire, it could result in a massive explosion, escalating the conflict to considerable proportions. However, Biden mentioned this week that attacks in the area would intensify soon, leading to nearly half of the tankers diverting around the Cape of Good Hope instead of using the Suez Canal.
In the case of containers (graph on the left), the numbers are even higher, with only about a third of the usual cargo circulation. Our take is that this situation may persist longer than initially estimated (for example, by Maersk), and we see interesting opportunities in various industries related to shipping.
Nevertheless, especially in the container sector, it must be clear to everyone that it is not a situation like what we saw in 2022, where freight rates increased significantly, directly boosting companies' margins. Now, freight rates are rising, but so is the distance covered by the ships (figure on the right). Therefore, even though margins and expectations for companies may improve, it is important to emphasize that it is not the same scale as in 2022.
If you are interested in this topic, we published an article about the Crude Tanker industry with one of the world's top shipping analysts three weeks ago.
So far, as we have discussed, the beginning of the year has been heavily influenced by the cooling expectations of interest rate cuts, both in Europe and primarily in the US, and its consequent impact on currencies, leading to a more conservative asset allocation (contrary to the last two months of 2023).
Starting from this week and especially the next one, the earnings season kicks in (so far, mainly banking and airlines have reported). This week, the focus will be on the Tech sector, including Netflix & 3M on Tuesday, Tesla, IBM AT&T on Wednesday, Visa & Intel on Thursday and the following week on discretionary consumption and energy. As usual, we will cover all companies within our universe (those we monitor weekly in the 3 stages of the portfolio management section: Portfolio, Watchlist, and Radar). This week, we have SLG and Marine Products.
Macro data
Europe & UK
Week marked by CPI increases in both the UK and the EU, which, although expected to be temporary, can influence policymakers decisions about interest rates.
CPI UE +2.9% (expected + 2.9%, previous +2,4%)
CPI UK +4.0% (3.8% expected, 3.9% precious) - Unexpected rise in CPI (in part due to higher tobacco prices. Core inflation was unchanged at 5.1%)
UK Retail sales -3.2% (0.5% expected, 1.4% previous)
United States
Retail sales 0.6% (0.4% expected, 0.2% previous)
Philadelphia Fed Manufacturing Index (Jan) -10.6 (-7 expected)
Existing Home sales 3.78MM (3.82MM expected, 3.82MM previous)
Rest of the World
GDP China +5.2% expected +5.3%
Guide to the US REITs industry
Introduction
Real Estate Investment Trusts (REITs) are a way to invest in real estate in financial markets. To qualify as a REIT, companies must have at least 75% of their assets invested in real estate, mortgage loans, shares in other REITs, cash, or government securities.
In contrast to traditional real estate investments (such as buying a building or a house), investing in REITs is characterized by its accessibility (the minimum investment is the price of the share, significantly lower than the equity required for a real estate investment), liquidity (buying and selling, like most stocks, is immediate), and low correlation with other assets.
It's important to note that since 1960, there has been a law mandating a minimum distribution of 90% of income earned from real estate investments directly to shareholders.
There are primarily two types of REITs: Equity and Mortgage.
Equity REITs focus on owning, managing, and operating income-generating real estate properties. These properties varies from Shopping Centers to Offices, Apartments, Hotels… (each representing a different segment that we cover in detail later). As previously commented, the main characteristics of Equity REITs are hedging inflation over time, high dividend income and low correlation with other asset classes. The US Equity REIT market is much higher than the Mortage REITs one ($1.28T vs $0.06T)
Mortgage REITs make and hold loans and other debt instruments secured by real estate collateral. Mortage REITs (mREITs) invest in residential and commercial mortgages, as well as residential mortgage-backed securities (RMBS) and commercial mortgage-backed securities (CMBS). One of the reasons why people invest in mREITs is because high dividends (as you can see in the picture below & explain later). The main risks of mREITs are interest rates, credit risk and pre-payment
There are also hybrid REITs and other classifications like public/private, which we won't delve into in today’s publication.
One interesting aspect of REITs is that, like other sectors, they have subsectors (Residential, Healthcare, Retail, etc.), each with its own characteristics that make them behave differently throughout the economic cycle.
Another characteristic difference is the method of valuation for a REIT, which differs from the valuation of a traditional company. While discounted cash flow (DCF) is a possibility, it is more common to use Funds from Operations (FFO) and Net Asset Value (NAV).
The goal today is to gain a better understanding of the US REIT industry, for which we provide a spreadsheet with data on all US-listed companies (plus several analysis included - The pictures before are a overall summary and the 190 list ranked by market cap - There are also several analyses by segment ). We will explain in detail the characteristics of their subsectors, valuation methods, and analyse the current situation and prospects for 2024.
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