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Quarter-End Insights

In Real Estate, We Expect Years of Strong Growth for Hotels, Healthcare Segments

No 5-star stocks in the sector, which is mostly fairly valued.

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The Morningstar US Real Estate Sector Index is up 19.6% over the trailing 12 months, outperforming the 14.4% performance of the broader U.S. equity market over the same period. However, much of real estate's outperformance in 2021 is the sector bouncing back from underperforming the broader equity markets in 2020 as fundamentals for many real estate subsectors didn't start to recover until coronavirus vaccines were widely available across the U.S.

Exhibit 1: Real estate has had a higher 12-month return than the U.S. equity index.

Chart comparing the performance of the real estate sector and broader market.
  - source: Morningstar

On a market-cap-weighted price/fair value basis, the real estate sector is trading at a higher valuation than our estimates compared with our total North American coverage, which is trading at a 2% discount to our fair value estimates at the end of the first quarter. Currently, 86% of the real estate sector is trading in 3-star range, 26% in 4-star range, and 11% at 2 stars, while no company is trading in either 5-star or 1-star range.

Exhibit 2: Few discounts among the real estate companies.

Bar chart showing star rating distribution among real estate subsectors.
  - source: Morningstar

Fear that the omicron variant would lead to an increase in cases and thus further shutdowns caused the divergence among the more sensitive subsectors in the fourth quarter. The hotel and healthcare subsectors were among those most hurt by shutdowns during the pandemic. While the vaccine allows travelers to return to hotels and keeps residents of senior housing facilities safe, travel restrictions and quarantines that may arise from the variants could cause a significant drop in occupancy for both subsectors. Despite short-term disruption, we continue to believe that both the hotel and healthcare subsectors will see years of strong growth ahead of them. Meanwhile, industrial and self-storage, subsectors that performed the best during the pandemic, have significantly outperformed as demand for shipping and storage space has continued to surge.

Since the start of the pandemic, the industrial and self-storage subsectors have performed the best overall. While both fell in the first few months of the pandemic, they returned to prepandemic levels by the summer of 2020. Then, as real estate fundamentals improved through 2021, they produced significant returns for investors. Meanwhile, the hotel and retail subsectors fell more dramatically at the start of the pandemic and, while both have improved since vaccines were introduced, both are significantly below the rest of the real estate subsectors, with most hotel stocks still trading below their prepandemic prices.

Top Picks

Macerich (MAC)
Star Rating: ★★★★
Economic Moat Rating: None
Fair Value Estimate: $28.50
Fair Value Uncertainty: Very High

Class A malls continue to outperform other forms of brick-and-mortar retail. The stock sold off significantly during the height of the pandemic as fears of the coronavirus impact on brick-and-mortar retail sales grew among investors. Macerich has long-term leases with tenants, so it continued to receive rent even during the worst months of the crisis. However, brick-and-mortar sales quickly rebounded as people returned to stores, with foot traffic at malls returning to prepandemic levels during the summer months of 2021. As a result, Macerich's occupancy levels and re-leasing spreads have improved across its portfolio.

Park Hotels & Resorts (PKw)
Star Rating: ★★★★
Economic Moat Rating: None
Fair Value Estimate: $25.50
Fair Value Uncertainty: Very High

While the coronavirus significantly diminished Park's operating results, with high-double-digit revPAR declines and negative hotel EBITDA in 2020, the company rebounded significantly in 2021. Leisure travel has recovered to near prepandemic levels, leading to a return of positive hotel EBITDA. However, business and group travel has been slower to return, as workers have yet to fully return to the office. Still, we think business and group demand will eventually return close to prepandemic levels by 2024, leading to years of strong growth for Park.

Ventas (VTR)
Star Rating: ★★★★
Economic Moat Rating: None
Fair Value Estimate: $69
Fair Value Uncertainty: Medium

Ventas owns high-quality assets in the senior housing, medical office, and life science fields. While the company's medical office and life science portfolios should be relatively unaffected by the coronavirus outbreak, the senior housing portfolio has experienced a very significant impact to occupancies, as the virus has the highest lethality rate among senior citizens. However, while the virus continued to hurt net operating income in 2021, the industry should see strong long-term growth from the coming demographic wave of baby boomers aging into senior housing facilities.

Kevin Brown does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.