Real Estate: Sector Underperforms in Third Quarter Despite Small Decline in Interest Rates

The Morningstar US Real Estate Index declined 2.2% over the trailing 12 months, significantly underperforming the 17.5% gain recorded by the broader US equity market during the same period. The sector also underperformed the broader market in the third quarter. Interest rates are up approximately 50 basis points from the low point seen last September, driving much of the underperformance.

However, real estate declined in the quarter despite interest rates generally falling—one of the first quarters in the past three years in which the relationship has not held up. Same-store net operating income growth has flattened out, with an average year-over-year growth rate of around 2%, as expense growth remains slightly above revenue growth in many sectors. Most companies reported results that were generally in line with or slightly above our expectations on second-quarter earnings calls, and our estimates for 2025 generally remain within management’s guidance for the year.

Same-Store NOI Grew Just 2.1%, Though Significant Difference by Sector

Real estate stocks are currently trading below their average fair value estimate. Names under our coverage currently trade at a discount to our estimate of fair value, which is better than the average in North America. Currently, 13% of the sector is trading in the 5-star range, 56% is in the 4-star range, 18% is in the 3-star range, 10% is in the 2-star range, while just 3% is in the 1-star range.

Falling interest rates drove real estate outperformance in the first quarter, though rising rates erased much of that outperformance in the second quarter. However, the relationship hasn’t held up in the third quarter, with the REITs underperforming despite falling interest rates. While REITs on average reported same-store net operating income growth of 2.1%, which is near inflation, during the second quarter, performance was bifurcated between three strong sectors and five with low to negative growth.

UST Rate Movements Have Been the Driving Factor Behind REIT Performance

Top Sector Picks

Americold Realty Trust

• Fair Value Estimate: $27.00
• Morningstar Rating: ★★★★★
• Morningstar Economic Moat Rating: None
• Morningstar Uncertainty Rating: Medium

Americold’s COLD stock price has corrected about 50% in the past year. Much of the correction can be attributed to concerns related to a difficult outlook in the near term, as occupancy rates have fallen and rents are coming under increasing pressure. The pressure on the core rental segment fundamentals is both a function of moderating demand and incremental supply side additions in recent years. There are indications that speculative supply growth will be lower in the upcoming years, supporting occupancy recovery. We agree that the near-term outlook may be difficult, but the current valuation provides an attractive entry point for long-term oriented shareholders.

Federal Realty Investment Trust

• Fair Value Estimate: $137.00
• Morningstar Rating: ★★★★
• Morningstar Economic Moat Rating: None
• Morningstar Uncertainty Rating: Medium

Federal Realty’s FRT high-quality retail centers should produce higher retail sales growth than the brick-and-mortar average, keeping occupancies high and driving high re-leasing spreads. Federal Realty’s portfolio has the highest average population density and per capita income among all shopping center REITs. The company’s strong internal and external growth prospects should also allow Federal to continue to support a high dividend yield. We believe the company has sold off due to 10% of rent coming from office tenants, but Federal’s high-quality portfolio should trade at a multiple premium to the industry and its shopping center peers.

Healthpeak Properties

• Fair Value Estimate: $27.50
• Morningstar Rating: ★★★★★
• Morningstar Economic Moat Rating: None
• Morningstar Uncertainty Rating: Medium

Healthpeak’s DOC management team strategically focused the company around the medical office and life science portfolios. These sectors should provide steady and recession-resistant revenue growth for the firm. Healthpeak’s development pipeline should also produce yields above the company’s cost of capital even in a higher interest rate environment, producing additional cash flow growth for shareholders. The company sold off due to rising interest rates, but we believe that the current market-implied cap rate undervalues Healthpeak’s portfolio of stable assets.