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REIT Fundamentals Improving

Chris Wimmer, CFA

Chris Wimmer: Year to date in 2018, credit spreads of the Morningstar Corporate Bond Index and our REIT Sector Index, with average ratings A- and BBB+, respectively, have widened relative to Treasuries in contrast to 2017, when both indices tightened throughout the year. Year to date, REITs have widened 18 basis points to 123 over Treasuries while the corporate index has widened 19 basis points to 115 over as volatility has picked up and investors expect interest rates to rise further.

From a fundamental perspective, REITs continue to improve balance sheets and credit profiles. When we look forward, key fundamentals we are most focused on include property-level cash flows, or what we like to call net operating income, or NOI.

We expect the better performing sectors, such as industrial warehouse and specialty--think data center and cell tower REITs--will produce NOI in the high-single-digit percent range, and maybe even low teens in some cases, given the expanding economy and manufacturing sector, as well as growth in e-commerce.

Weaker sectors, such as retail, will be challenged to produce growth in NOI and more than a few retail REITs will face declining NOI as a result of the weak environment for brick-and-mortar retailers.

We anticipate that the expanding economy, new tax regime, and regulatory relief for businesses and consumers to ultimately benefit REITs. Real estate is in the end driven by supply and demand, and more aftertax dollars will mean that office REITs will see more demand for work space as businesses hire; industrial REITs will see more demand for warehouse space as manufacturing accelerates; and consumers order more goods online with more after-tax dollars in their pockets. Multifamily apartment REITs will also benefit, as their fundamentals are tied to employment, which will remain solid under the expanding economy. Finally, despite the economic relief, retail REIT will continue to struggle against secular headwinds.