REITs Have Become The New Flight-To-Quality Asset Class (2024)

With this past week's strong performance, with gains of 25% so far this year, the broad-based REIT ETFs--as measured by Vanguard Real Estate ETF (VNQ) and iShares U.S. Real Estate ETF (IYR)--continue to outperform the S&P 500, which has climbed roughly 20%.

However, not all REITs are seeing a windfall as evidenced by the 55% performance gap between the best- and worst-performing REIT sectors.

As Alex Pettee with Hoya Capital real Estate explains, “the U.S. housing sector has climbed 27% this year led by the nearly 50% surge in homebuilders. At 1.76%, the 10-year yield has retreated by 93 basis points since the start of the year and is roughly 150 basis points below peak levels of 2018, around 3.25%.”

Data center REITs have surged by more than 40% this year, following the worst year for the sector since NAREIT formally began tracking the group in 2015. The sector has become even more heated as CyrusOne (CONE) has become a prime-time takeover target, according to Bloomberg: (CyrusOne) “has drawn interest from rival Digital Realty Trust” and “investment firms EQT Partners and Digital Colony Partners have also partnered to pursue a potential deal for the company.”

Cell tower REITs have also boomed this year, returning more than 43%, due to their massive scale advantage and insatiable demand for 5G expansion.

Vanguard Real Estate ETF, the dominant REIT ETF, which has a market cap of more than $36 billion, owns 186 stocks, including many of the "who’s who" of the largest REIT operators, including such players as American Tower (AMT), Crown Castle International (CCI), Prologis (PLD), Simon Property Group (SPG), Equinix (EQIX), Public Storage (PSA), Welltower (WELL), Equity Residential (EQR) and AvalonBay (AVB).

Notably, American Tower (6.9% exposure) and Crown Castle (4.1% exposure) represent around 11% of VNQ’s portfolio, providing rocket fuel to VNQ’s success year-to-date.

Manufactured housing REITs have also surged, driven primarily by the so-called “silver tsunami,” writes to Greg Kuhl, CFA, portfolio manager with Janus Henderson. He says this of

the raging demographic drivers for health care: "It should come as no surprise that baby boomers remain a key demographic for real estate owners. In real estate, conventional wisdom seems to be that those businesses directly associated with health care delivery, such as senior living facilities, are best positioned to benefit from the silver tsunami.”

However, Kuhl explains, "manufactured housing communities for new retirees, for example, are meeting the needs of aging households today, not 10 years from now."

Of course, not all property sectors are booming, as the mall sector has drastically under-performed other property sectors, delivering returns of -9.7% year-to-date.

One other sector that’s struggling is the lodging category (7.5% YTD), perhaps a harbinger since this particular asset class has historically underperformed during a recession. I find it odd that most lodging REITs are generating flat to modest NOI (net operating income) growth during strong economic times.

So why have REITs seen this so-called “flight to quality” lately?

Keep in mind that certain stocks (and of course that includes REITs) are better prepared to perform during periods of chaos, as Thomas Kenny explains, “The flight to quality is the dynamic that unfolds in the markets when investors are more concerned about protecting themselves from risk than they are with making money. During times of turbulence, market participants often will gravitate to investments where they are least likely to experience a loss of principal.”

This “flight-to-quality” phenomenon occurs when investors sell what they perceive to be higher risk investments, and purchase safer investments. This is considered a sign of fear in the marketplace, as investors seek less risk in exchange for lower profits. As Hoya Capital Real Estate explains, “For the second time this decade, the Federal Reserve lowered benchmark interest rates in response to signs of slowing global economic growth and weakening inflation expectations. U.S. equity and bond markets reacted favorably to the policy announcement in which eight of the ten voting members agreed to lower rates by at least a quarter percentage point. An indication that investors interpreted the Fed commentary as quite "dovish," the 10-year Treasury yield pulled back by 15 basis points on the week, helping to drive outperformance in the yield-oriented segments of the equity market.”

REITs have become the safe haven asset class, in which an investor can obtain high yield and sound price appreciation. Of course this is great news for REIT investors, and yours truly – my portfolio has returned over 24% year-to-date and over 18% over two years.

It seems that Mr. Market has become increasingly fascinated with the predictable rent checks that REITs generate, and the growth doesn’t seem to be slowing down anytime soon. As Calvin Schnure, Nareit’s senior vice president, research & economic analysis, explains, “REIT earnings are at a record high. Funds from operations totaled $16.5 billion in Q2, according to the Nareit T-Tracker, 13.5% higher than three years ago…and despite these clouds on the horizon (trade wars, weakening manufacturing sector, etc…) the sustained modest growth that is likely to result has proven to be a good environment for commercial real estate.”

As my mother used to say, “it’s time to make hay while the sun is shining” and while REIT valuations are becoming a bit pricey, the hard assets driving returns are highly sustainable. So long as the economy continues to grow, REITs should maintain their premium value, something that shouldn’t be a surprise given the fact that REITs have become a core asset class (as part of GICS) owned by 80 million Americans through their retirement savings and other investment funds (according to NAREIT).

Disclosure: I own shares in CyrusOne, Digital Realty, Crown Castle International and SPG.