Kwarkot
Publicly traded real estate investment trusts ("REITs") have long been favored by investors of all types. With a competitive long-term performance and stable dividend yields, it's no wonder that 83% of registered investment advisors recommend REITs to their clients, according to the National Association of Real Estate Investment Trusts ("NAREIT").
However, with the current pullback in the sector, it's important for investors to be selective and identify the REITs with the best risk-adjusted prospects. In this article, we'll explore the current state of REITs, the opportunities they present, the risks they entail, and the top industry picks for 2023.
Current State of REITs
YTD through November 30, 2022, the FTSE NAREIT All Equity REIT index ("FTSE-A.E.R") is down 21%, outperforming every major index except the Nasdaq. While this underperformance may give some investors pause, it's essential to consider the historical performance of REITs.
In 15 of the last 25 years, the FTSE-A.E.R index has actually outperformed the S&P 500, while also offering a dividend yield that is more than double that of the S&P 500. Despite the recent downturn, REITs have a track record of resilience and long-term value.
Opportunities Embedded in REITs
The recent underperformance of REITs presents an attractive entry point for both new and existing shareholders. Besides the potential for capital appreciation, REITs also offer income investors a steady stream of dividend payments. Additionally, investing in REITs allows for better portfolio diversification, which is increasingly important in today's market.
One of the advantages of investing in REITs is the simplicity of their business model. Most REITs primarily lease space and collect rent on real estate properties, with at least 90% of their taxable income distributed to shareholders as dividends. This simplicity enables investors to easily follow and compare sector performance.
The Current Risks Associated with REITs
While REITs offer numerous opportunities, it's crucial to consider the risks involved. One risk is the relatively higher debt loads of REITs compared to broader market indexes. Although the industry has significantly reduced leverage since the Great Financial Crisis, higher debt levels could pose a challenge, particularly if real estate values decline significantly.
Moreover, REITs face competition from other investment options. The average dividend yield of the FTSE-A.E.R index is 3.68%, which is higher than the S&P 500 but lower than some risk-free alternatives. Investors may opt for high-yield savings accounts or treasury bonds, which offer attractive interest rates.
Top Industry Picks
1. Healthcare REITs
Healthcare REITs provide a defensive investment option that is less susceptible to economic fluctuations. With an aging population driving demand for medical office buildings and skilled nursing facilities, this sector has favorable long-term prospects. Notable names like Medical Properties Trust and Omega Healthcare Investors offer attractive dividend yields and significant upside potential.
2. Self-Storage REITs
Self-storage is another needs-based industry worth considering for 2023. Despite a decline this year, the sector has a history of performing well during economic downturns. People's need for storage remains constant, and when times are tough, it becomes even more crucial. National Storage Affiliates is a top name within the self-storage sector, with a modest valuation and a strong dividend track record.
3. Industrial REITs
Industrials are a sector with enormous pricing power and low vacancy rates. Though it has already experienced a run-up, there is still significant potential within key names, such as Plymouth Industrial. This sector is well-positioned for a rebound in valuations in the upcoming periods.
Top Overall Industry Pick: Offices
While office REITs have faced challenges due to the rise of hybrid working arrangements and an oversupply of lower-quality buildings, the sector presents an excellent opportunity for those seeking a rebound. Despite some dividend cuts, most major office components continue to post strong leasing figures and positive occupancy trends. Piedmont Office Realty Trust and Highwoods Properties are two names to watch in this sector.
Conclusion
While REITs have faced a setback in 2022, their future prospects remain promising. Investors need to carefully consider the opportunities and risks associated with the different sectors within the REIT space. Healthcare, self-storage, and industrials offer attractive options for investors seeking diversification and potential upside. Offices, although currently under pressure, have the potential for a significant rebound in 2023. By thoroughly analyzing the performance, risks, and opportunities of each sector, investors can make informed decisions about the best REITs to invest in for 2023.