Where the value lies
REIT stocks overall right now are relatively inexpensive compared with the underlying value of the real estate they own. Wells Fargo Investment Institute’s 2018 Outlook notes that REITs have been trading at a 4.8% discount to the value of their assets, lower than the 2.5% premium they’ve averaged since 1990.
“We believe the place to stay away from is retail,” LaForge says. “They’ve hit kind of a watershed period.” E-commerce companies have become a serious threat to traditional retail businesses.
A stronger area may be lodging REITs, which own hotels and motels and are “relatively cheap,” LaForge says. “I believe that trend will probably continue.”
REITs in 2018
REIT values dropped in the summer of 2016 as 10-year Treasury note yields started to rise. “It spooked investors,” LaForge says. “REITs have never really recovered that premium.”
If U.S. Treasury yields continue to rise this year, as many expect, investors may move their money into government debt that many consider to be a safer investment, which could push down REIT values.
On the other hand, REITs are often seen as a defensive investment during stock market downturns. Over the last few market downturns, LaForge says, REITs, when measured by the FTSE NAREIT All Equity REITs Index, have outperformed the S&P® 500 index.
In such cases, investors flock to REITs because of their perceived strengths: Their values are based on real assets — real estate — rather than more subjective assets such as the value of a consumer brand, and they pay steady dividends.
LaForge says Wells Fargo Investment Institute is forecasting total returns for REITs in the mid to high single digits for 2018. (Note that total return is the dividend plus the return from an increase in share price.)
Even when stock prices are dropping, companies can still pay dividends to investors, making them more attractive. And REITs usually pay higher dividends. REIT yields average about 4.5% compared with a 2.5% average yield for all stocks.
REITs may also be attractive during inflationary periods, LaForge says.
“They have the potential to be pretty good at being a hedge against inflation,” he says, because property managers can increase rental rates to combat inflation.”
There are special risks associated with an investment in real estate, including credit risk, interest rate fluctuations and the impact of varied economic condition.
There are no assurance that forecasts will be met.