Appeal of real estate trusts for income set to fade

By Jame DiBiasio

Added 24th October 2016

Real estate investment trusts (Reits) may see total returns come off recent highs by the end of 2016, as energy infrastructure and dividend-paying stocks take the lead among equities that provide regular income, said Mark McAllister, senior portfolio manager at Clearbridge Investments, a Legg Mason affiliate.

Appeal of real estate trusts for income set to fade

Mark McAllister

Reits have performed well since the ‘taper tantrum’ of 2013, when then-Federal Reserve head Ben Bernanke first suggested an end to the central bank’s programme of buying assets, he said.

According to data from the firm, US Reits gained 30.4% in 2014 and a modest 2.5% in 2015, thanks to rising real-estate values and declining capitalisation rates (the ratio between a property’s net operating income and its original capital cost). But that performance averaged over those two years may not sustainable.

“Dividend stocks may end up outperforming Reits,” he said. “Reits have enjoyed a great run, but it’s late in the cycle and the risks have increased.”

Among those is new supply. Construction of new properties was initially slow in the aftermath of the 2008 global financial crisis and tight supply boosted valuations. That has recently changed across many parts of the real-estate world, including apartments, hotels and self-storage. While rents are still growing, that growth is decelerating. The firm describes US Reits as “fair value”.

McAllister’s team invests in what he describes as income with a value focus. There are three components: Reits, dividend stocks and listed energy infrastructure. All of them face risks, but so far in aggregate they continue to deliver a premium of 100-150 basis points when compared to the Dow Jones US Select Dividend Index, he said.

"Reits have enjoyed a great run, but it’s late in the cycle and the risks have increased"

Dividend stocks did well in 2013 and 2014, McAllister said. In yield terms, he said pharmaceutical and fast-moving consumer goods stocks that pay dividends return around 3%, versus 2% for the S&P500 and – more importantly – versus 1.75% for a 10-year US Treasury bond and nothing, or negative yields, for many European government bonds.

Since then, these stocks have been eclipsed by big Silicon Valley names, but McAllister said institutional investors will continue to seek dividend stocks so long as interest rates are low.

The biggest and most obvious risks have been in the energy area. The biggest factor behind energy stock performance is the price of oil and gas, which has fallen precipitously over the past two years. Price volatility in turn creates uncertainty over production.

But energy infrastructure is the asset class with the greatest likelihood of outperforming, he said, as it is a play on US energy production, which survived a Saudi-inspired price war and will continue to grow.

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