• / Free eNewsletters & Magazine
  • / My Account
Home>Research & Insights>Investment Insights>Our Outlook for Real Estate Stocks

Related Content

  1. Videos
  2. Articles
  1. Investors' Biggest Mistakes of 2011

    Sanibel Captiva's Pat Dorsey discusses what investors might regret from 2011, and how they can avoid those mistakes in 2012.

  2. 2 Stocks for Investors With an Appetite for Risk

    Real-estate service firms CBRE Group and Jones Lang LaSalle have wide moats, good growth prospects, and are trading at about a 30% discount to our fair value estimate.

  3. Consumers Have More Dry Powder Than It Appears

    Lower inflation trends plus an upcoming Social Security cost-of-living adjustment should contribute to consumers' staying power, says Morningstar's Bob Johnson.

  4. Gold Stocks Ready to Outperform

    Although gold equities have lagged the performance of bullion, miners will do a much better job of executing and delivering margin expansion to investors, says Fidelity's Joe Wickwire.

Our Outlook for Real Estate Stocks

In general, real estate stocks have tempered toward fair value.

Jason Ren, 12/29/2011

--The intrasector flight to more defensive names tempered in the fourth quarter.

--Other than lodging, recent macro-volatility doesn't suggest high potential for materially sharp reversals in firming near-term operating metrics.

--Relative to private investors, and the public non-traded REIT space, publicly traded REITs remain well-positioned.

Along with the rest of the market, real estate stocks gyrated in the fourth quarter. However, relative to fair value, real estate stocks will likely finish the quarter at approximately fair value, similar to levels three months prior. This is in stark contrast to heights achieved earlier this year, which saw highs of nearly 1.3 times fair value, prior to macroeconomic concerns coming to a head. We highlighted five stocks at the close of the third quarter, Alexandria Real Estate Equities ARE, Diamondrock Hospitality DRH, Health Care REIT HCN, Jones Lang LaSalle JLL, and St. Joe JOE. Although we continue to highlight these firms, we caution that the five are less compelling than they were at the close of the third quarter, as Alexandria, Diamondrock, Health Care REIT, Jones Lang LaSalle, and St Joe have risen by approximately, 8%, 33%, 7%, 10%, and 6% respectively, since the publication of the last quarter-end insight.

Since peak pricing premiums earlier this year, macroeconomic uncertainty and regulatory scrutiny on tenant revenue have taken their toll, dropping the sector to roughly fair value. Within the sector, a flight to safety toward cyclically defensive property sectors continues to exist, owing to fears of a slowdown in the macroeconomy. Additionally, stocks less dependent on near-term access to capital markets continue to be priced at a premium, as well.

Heading into 2012, we remain wary of the lofty valuations afforded to the property classes in REITs that have benefited from recent macroeconomic volatility. Still, while some sectors--especially those that renew leases on a near-term basis, such as lodging--could see a reversal in operating performance, we generally think that the fundamental improvements seen through most of 2011 should hold in the near term. This bodes reasonably well for investors.

Industrywide, REITs are currently yielding around 4%, and dividend payout as a percentage of funds from operation, in aggregate, is approximately 70%, according to the National Association of Real Estate Investment Trusts. We continue to think that the commercial real estate cycle is in the early innings of improvement, and though there could be payout concerns on a granular company-by-company basis, the industry as a whole likely won't suffer rolling dividend cuts across the board.

Property classes that rely upon shorter-term leases--apartments, lodging, and storage--continued to see rental rate improvement in the third quarter, which generally led to operating income margin expansion. However, because those classes renew leases on a near-term basis, their revenue streams are more cyclically sensitive. Although lodging REITs appear undervalued to us, we caution that they are the most cyclically concerning. While occupancy gains since the trough of the recession have the lodging REITs under coverage within striking distance of occupancy levels last seen in peaks last decade, booking windows have remained short in the space, so gains could deteriorate quickly. We also note that the third quarter ended in early September for both Diamondrock and Host, prior to heightened levels of dislocation during the close of that month. Still, with balance sheets right-sized since the close of the recession and low levels of recourse debt due in the near term, we think lodging REITs, like most other REITs under coverage, remain in good financial health.

Jason Ren is a senior stock analyst with Morningstar.

©2017 Morningstar Advisor. All right reserved.