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TCW Insight Article “REITS: Poised for Outperformance?”

November 7, 2017

TCW Insight Article “REITS: Poised for Outperformance?”

November 7, 2017 | James Sprow | Blue Vault

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In a Viewpoint article published on November 6, TCW researchers Brivanlou and Tawinganone make a case for REITs to rebound significantly relative to broader market equities over the near- to medium- term. They see the potential outperformance driven “by two primary factors: (i) expectations for growth and tax reform in the U.S. are now likely to be meaningfully priced in to the valuation of stocks, and (ii) REIT valuations in many sectors are attractive from a relative standpoint, setting the stage for a wave of flows seeking reliable income with potential for growth.”

The authors point out that REITs have outperformed other major asset classes over the past 25 years.  However, from 10/31/2016 to 10/31/2017, the S&P 500 Index posted total returns of 23.6% vs. only 5.6% for the MSCI U.S. REIT Index (RMZ). They point out that this disparity (-18%) is as extreme as it has been since the financial crisis. The outperformance by the stock market has been fueled in part by the election of Donald Trump and the potential for higher economic growth through deregulation, corporate tax reform and infrastructure spending. The authors state that lightly regulated tax-exempt REITs would not benefit as much from the new administration as more cyclically exposed, heavily regulated or tax-paying companies. 

Investors may be influenced by the perception that the REIT sector is sensitive to rises in interest rates. The authors use historical evidence to debunk the misconception that REITs will underperform in an environment of rising rates. Over the past 25 years, there have been seven periods during which U.S. 10-year Treasury Bond yields rose significantly. In three of these periods, REITs earned robust positive total returns, and in two periods REITs outperformed the S&P 500. Relative performance has actually been favorable since 2000, with REITs on average outperforming the S&P 500 by 7%. 

REIT income return has historically exceeded the rate of inflation, as the income component of REIT returns has exceeded inflation in 14 of the past 15 years. Real estate tends to outperform stocks during periods of rising inflation, as real estate owners have the ability to raise rents at least commensurately.

The authors conclude their analysis with the following: “Over the long term, income investing is unlikely to remain out of favor for long and investors looking for safety and yield will be increasingly drawn to REITs. Real estate rental income is much more predictable than more discretionary sources stemming from the sale of products or services. With the demographic trend of the aging of the population fueling an ever-expanding appetite for retirement income, it is safe to conclude that REIT investing will be a main area of focus for decades to come.”

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