3 Equity REIT Stocks Poised to Escape COVID-19-Led Industry Scare

Social distancing or rather physical-distancing measures to curb the spread of coronavirus have resulted in a deviation between different sectors of the economy on one side, involving low face-to-face contact, showing resilience and even gaining, and the other side with higher risks for infection significantly bearing the brunt.

Similarly, with the Zacks REIT and Equity Trust - Other industry offering the real estate structure for several economic activities, be it real or virtual, there are pockets of strengths even amid the pandemic-induced industry weakness. Particularly, with concerns about face-to-face contact spurring online interactions and purchases, data-center REIT Digital Realty (DLR) and industrial REITs, including Rexford Industrial Realty (REXR) and EastGroup Properties (EGP), that support digital economy are likely to continue benefiting.

About the Industry

The Zacks REIT and Equity Trust - Other industry is a diversified group, covering REIT stocks from different asset classes like industrial, office, lodging, healthcare, self-storage, data centers, towers and others. The REITs rent spaces in these properties to tenants and earn rental incomes.

Notably, the performance of Equity REITs depends on the underlying asset dynamics and hence, delving into the fundamentals of those asset categories is all the more essential before making any investment decision. It is also highly important to figure out whether or not the social-distancing related behaviors will create only short-term impact or induce long-term structural changes.

What’s Shaping Future of the REIT and Equity Trust - Other Industry?

REITs involving low levels of face-to-face interactions to gain: The pandemic and concerns about face-to-face contact have significantly prompted online interactions and purchases. This shift from in-person communication and commerce to the electronic platform is helping sectors like industrial, infrastructure, and data centers to prosper, a trend that is likely to continue in the foreseeable future. However, social-distancing requirements have also propelled the work from home wave. Along with the overall economic turbulence and job losses, the remote working wave has substantially affected demand for office spaces. Office-using employment has shrunk, affecting occupancy level and resulting in significant negative absorption. This is expected to prevail in the near term, and affect asking rents amid soft tenant demand and increasing available spaces for leases.

REITs having high potential exposure to infection to suffer: The present situation is challenging for lodging/resort REITs, which have the highest potential exposure to the COVID-19 virus due to the face-to-face interactions. This sector is unlikely to see a full recovery until the crisis dissipates or a vaccine is rolled out. In addition, though personal and vacation travel might recover and create demand for lodging spaces, business travel will likely be slower to recapture its lost ground, thanks to the online meetings and teleconferences substituting a number of in-person events. For healthcare REITs, demand for life-science real estate has been picking up with effective diagnostics, testing, therapies and vaccines being required to fight the pandemic. Nevertheless, with senior housing assets constituting a majority of REIT portfolios, there is a strain on occupancy level and rate. Also, expenses are going up for providing a safer environment in case of senior housing, skilled nursing and medical office buildings.

Macroeconomic Issues, Soft Rental Demand and Rent Collection Woes: The real estate sector’s prospects get a boost when economy progresses. This is because growth in the economy translates into greater demand for real estate, higher occupancy levels and landlords’ greater power to ask for higher rents. And even though the economy managed to recover in the third quarter following a drastic decline in the second, households and businesses are yet to gain more confidence as any solution to control the pandemic has not been found yet. Therefore, the pace of recovery in the interim period is likely to remain sluggish. Amid this, rental demand for a number of asset categories will continue being soft, initial lease-up of new deliveries might be challenging in the days to come, and rent discounting as well as use of concessions will be rampant. Furthermore, amid protracted economic recovery, stress on tenants’ financial capacity might prevail and result in rent-collection issues. Therefore, REITs with a better balance-sheet position and ample liquidity are well poised to sail through the challenging times and bank on the solid opportunities.

Low Rate Environment: Nevertheless, Equity REITs will continue benefiting from the Fed’s low-rate stance because REITs depend on debt for business. Thus, these companies benefit from the lower borrowing costs in a low-rate environment. Additionally, low interest rates contribute to higher valuations. Further, REITs are often treated as bond substitutes for their high-dividend paying nature. Also, REITs offer protection from inflation as both rents and valuations get a boost when prices flare up, in turn, supporting cash flows from their properties and driving dividend growth. Apart from this, Equity REITs have been proactive in the capital market in recent years. These companies have opportunistically used the low-rate environment to make their financials more flexible, which is encouraging down the line for the REITs’ operational efficiencies.

Zacks Industry Rank Indicates Bleak Prospects

The Zacks REIT and Equity Trust - Other industry is housed within the broader Finance sector. It carries a Zacks Industry Rank #223, which places it at the bottom 12% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates bleak near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

The industry’s positioning in the bottom 50% of the Zacks-ranked industries is a result of the negative funds from operations (FFO) per share outlook for the constituent companies in aggregate. Looking at the aggregate FFO per share estimate revisions, it appears that analysts are losing confidence in this group’s growth potential. Over the past year, the industry’s FFO per share estimate for 2020 and 2021 moved 22.8% and 5.6% south, respectively.

Before we present a few stocks that you might want to consider for your portfolio, let’s take a look at the industry’s recent stock-market performance and valuation picture.

Industry Mixed on Stock Market Performance

The REIT and Equity Trust - Other Industry has outperformed the broader Zacks Finance sector but lagged the S&P 500 composite in a year’s time.

The industry has depreciated 11.8%, during this period,as against the S&P 500’s rally of 14.2%. Meanwhile, the broader Finance sector has lost 12%.

One-Year Price Performance

Industry’s Current Valuation

On the basis of the forward 12-month price-to-FFO ratio, which is a commonly-used multiple for valuing REIT - Others, we see that the industry is currently trading at 18.76X compared with the S&P 500’s forward 12-month price-to-earnings (P/E) of 22.10X. The industry is trading above the Finance sector’s forward 12-month P/E of 15.72X. This is shown in the chart below.

Forward 12 Month Price-to-FFO (P/FFO) Ratio

Over the last five years, the industry has traded as high as 19.33X, as low as 14.32X, with a median of 16.14X.

3 Equity REIT – Other Stocks to Keep a Close Eye on

Digital Realty Trust Inc.: Digital Realty Trust offers data-center, colocation and inter-connection solutions for domestic and international tenants through its portfolio of data centers located throughout North America, Europe, Asia and Australia. Remarkably, data centers are poised to gain from the heightening reliance on technology and acceleration in digital-transformation strategies by enterprises amid the coronavirus pandemic. Capitalizing on such factors, this data-center REIT is expanding its portfolio on accretive acquisitions and development efforts. Such moves are supported by a healthy balance sheet.

Digital Realty currently carries a Zacks Rank #2 (Buy). The Zacks Consensus Estimate for the 2020 and 2021 FFO per share moved north to $6.08 and $6.54 over the past two months, reflecting positive sentiments. The company’s shares have rallied roughly 30% so far in the year.

You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Rexford Industrial Realty: This industrial REIT is focused on acquisitions, ownership and operation of industrial properties situated in the Southern California in-fill markets. This Zacks #2 Ranked company is poised to benefit from its unmatched portfolio in the nation’s largest, most sought-after industrial property market. It delivered better-than-expected performance in terms of FFO per share and revenues in the July-September quarter. The REIT gained from growing tenant demand from a variety of industries, including the exponential rise in e-commerce.

The Zacks Consensus Estimate for the 2020 and 2021 FFO per share have been revised nearly 1% and 3% upward over the past 60 days to $1.28 and $1.35, respectively, indicating year-on-year improvement of 4.1% and 5%. The stock has appreciated 23.4% over the past six months.

EastGroup Properties, Inc.: This REIT is focused on developing, acquiring and operating of industrial properties in key Sunbelt markets throughout the United States. The company particularly gives weightage to states like Florida, Texas, Arizona, California and North Carolina. It is well poised to benefit from the likely shift toward carrying more inventory, faster population growth in the Sunbelt markets and the increased e-retail demand. It currently carries a Zacks Rank of 2.

Over the past month, the Zacks Consensus Estimate for FFO per share for 2020 and 2021 witnessed northward revisions to $5.32 and $5.50, respectively, calling for year-over-year growth of 6.8% and 3.5%. The stock has also rallied roughly 33% over the past six months.

Note: Funds from operations (FFO) is a widely used metric to gauge the performance of REITs rather than net income as it indicates cash flow from their operations. FFO is obtained after adding depreciation and amortization to earnings and subtracting the gains on sales.

5 Stocks Set to Double

Each was hand-picked by a Zacks expert as the #1 favorite stock to gain +100% or more in 2020. Each comes from a different sector and has unique qualities and catalysts that could fuel exceptional growth.

Most of the stocks in this report are flying under Wall Street radar, which provides a great opportunity to get in on the ground floor.

Today, See These 5 Potential Home Runs >>

Click to get this free report Rexford Industrial Realty, Inc. (REXR) : Free Stock Analysis Report EastGroup Properties, Inc. (EGP) : Free Stock Analysis Report Digital Realty Trust, Inc. (DLR) : Free Stock Analysis Report To read this article on Zacks.com click here. Zacks Investment Research