REITs topped our coverage universe for December and 2021 total returns
At the sector-level, US Real Estate’s performance was second only to the Energy sector last year
Valuations are now extremely high versus history. As a result, our long-term return forecast for the space is bearish despite near-term positive momentum.
REITs were very strong to round out 2021. The group had a mediocre 2020 as some segments of the REIT market were hit hard by COVID’s impacts, but a booming global real estate market buoyed the sector in 2021. It was one of the few S&P 500 sectors to end the year at an all-time high. This week’s featured chart is the Dow Jones US REIT Index, which has more than doubled from its pandemic low.
Color on Recent Strength
US REITs gained ground in relative terms last week, too. The advance was driven by strength among the industrial, storage, and residential segments. For December, US REITs topped our list of best-performing assets areas we cover.
Looking Back on Last Year
US REITs returned more than 35% in 2021 followed by US MLPs with a total return of slightly less than 30%. It was a comeback year for REITs. Back in May, we highlighted the space as one to watch for the balance of the year given the sharp recovery among some important REIT niches.
From Ruins to Riches
Before that article, we detailed how REITs were taken to the woodshed during the pandemic. The market is still somewhat bifurcated as industrial, storage, and residential markets are booming while retail and hotel/resort REITs might still have a ways to go on the road to a full recovery. Office REITs could face a tough road ahead, too.
Featured Chart: Dow Jones US REIT Index Surges to an All-Time High
An Inflation Hedge?
REITs are an interesting area for investors right now. The sector can be seen as a solid inflation hedge since, by definition, at least 90% of profits must be paid out as dividends to investors. Money flows straight to shareholders.
Also, REITs tend to be less labor-intensive than other sectors, so even if wages rise dramatically in 2022, REITs could be buffered from that risk. Investors should monitor the cost of capital as that is a bigger piece of financing. Hence, when interest rates rise, that can be a negative for REITs.
REITs Rallied with Rising Rates
Interest rates rise for good reasons sometimes. Take 2021 as an example. The US 10-year Treasury yield went from 0.93% at the start of last year to 1.51% by the end of 2021. The S&P Real Estate Sector returned 46% over the last 52 weeks, second only to the Energy sector.
But the Valuations...
Not everything is coming up roses for REITs. Valuations are hugely stretched. US REIT valuations versus history show a composite valuation Z-score about 2 standard deviations above the long-term average. Global REITs are just slightly less expensive.
Bottom Line: REITs made a huge comeback in 2021. The second-best performing sector last year now finds itself with sky-high valuations as property values have soared. Long-term, we see poor returns for the space despite the near-term positive momentum.
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