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Ahead of GICS Change, a Review of REIT Outperformance

R eal estate industry observers in recent months have made a sport out of calling market peak, but the present cycle appears to have entered extra innings.

REITs bounced back significantly from their February lows to outperform the S&P 500 by a healthy margin in the first half, according to SNL data. Year-to-date through July 18, the SNL U.S. REIT Equity index returned 16.0%, while the S&P 500 returned 7.3%. The 10-year U.S. T-note saw its yield fall 30.0% over the same period.

REITs tend to outperform in low-interest rate environments and when the economy is on the up-and-up, but this cycle has witnessed a rare confluence of additional REIT market drivers, according to Bruce Garrison, senior portfolio manager of Chilton Capital Management's REIT strategy.

"We have postulated from 2008 that it was going to be one for the record books in its length," Garrison said of the current real estate cycle, "And we still abide by that prognostication."

 

In an interview, Garrison reeled off a list of factors working in REITs favor: Healthy, low-leverage balance sheets; an influx of foreign capital looking to invest in U.S. real estate; a broader flight to asset quality and safety; an unusually long stretch of unusually low interest rates; and a supply picture that, in contrast to previous cycles, has remained in check.

Garrison said the upcoming carve-out of real estate from financials in the influential Global Industry Classification Standard, or GICS, will bolster REIT outperformance. Some financials-focused funds may offload REITs as a result of the classification change, but on balance, there will be a substantial inflow of capital to the space.

"We've seen studies that, if you take all the '40 Act funds and bring those funds up to the market weight where they should be, post-GICS, then there's a hypothetical net buying power of over $100 billion," Garrison said. "So the positives more than outweigh the negatives."

The GICS change likely already is behind some of REITs' outperformance year-to-date, he added.

"Most investors in stocks have been underweight REITs forever," Garrison said. "I think the tide is going out on those guys, and it's going to show how badly underinvested they are. And I bet they're starting to add to their holdings, and it's probably helped considerably in the last couple of months."

 

The SNL U.S. REIT Equity index, notably, has outperformed the 10-year treasury note and the S&P 500 over the past 10 years. The SNL U.S. REIT Equity index had an average annual total return of 10.3% from 2006 to 2015, compared to an average annual total return of 9.1% for the S&P 500 and a 0.4% average annual change in yield for the 10-year treasury note.

Between 2000 and 2015, the average annual total return for the SNL U.S REIT Equity index was 14.3%, compared to 5.8% for the S&P 500 and negative 1.7% for the 10-year treasury note yield.

The 10-year treasury note outperformed the U.S. REIT Equity index only four of the last 16 years. The S&P 500 outperformed the U.S. REIT Equity index in just two of the last 16 years — in 2007 and 2013.

Specialty REITs had the most top 25 performers over the past 10 years, at seven. Equinix Inc., a data center company that converted to a REIT on Jan. 1, 2015, led all REITs with an 803.5% 10-year total return as of July 18. Equinix averaged a 33.7% annual total return from 2006 to 2015.

Health care REITs had the second-highest number of top performers, with six companies in the top 25. National Health Investors Inc. led healthcare REITs with a 10-year total return of 495.6% as of July 18. National Health Investors had an 18% average annual return from 2006 to 2015.