In a market in which REITs are trading at a weighted average 23% premium to consensus-estimated NAV, it’s important investors navigate the industry’s priced-in optimism to differentiate the good names from the bad ones.
“Whereas over the past two years, simply making the global decision of whether to be invested in U.S. REITs or not was the most critical investment decision, from here we believe that picking sectors and picking stocks will be very important, as we don’t see the REITs moving as a group, as they have over the last two years,” said Senior Analyst Paul E. Adornato, who covers the REIT sector for BMO Capital Markets’ equity research group. Adornato currently has a “market-perform” rating on the industry as a whole, although he says he is most positive on the industrial REIT sector.
“We like industrial because the asset type is not terribly overbuilt. It’s very generic in nature and when the underlying fundamentals improve, we feel that could set the stage for a relatively rapid improvement in the investment characteristics of that property type,” Adornato said, citing the two main demand drivers for industrial REITs to be replenishing inventory levels and growing international trade volumes. His top picks in this sector are First Potomac (FPO), Duke Realty (DRE) and DCT Industrial (DCT).
Apartment REITs represent another sector in which Adornato sees growing opportunity.
“Over the next 12 to 24 months, we think that there will be a net negative supply of apartments. That is, obsolescence will be greater than new construction,” he said. “That coupled with a stabilizing economy and a potential return to job growth over 24 months should create the conditions for very positive rental rate growth for multifamily owners over 24 months.”