Blood on REIT Streets Could Signal Buying Opportunity

Year-to-date, the largest exchange traded fund dedicated to real estate investment trusts (REITs) is saddled with a small loss, while the S&P 500 is higher by about 15%.

It’s just one example. However, it illustrates the point that many market participants are cautious, if not exceedingly bearish, on real estate equities. By virtue of real estate being the smallest sector weight in the S&P 500, novice investors may not be skittish about the sector’s lethargy. Conversely, REIT tea leaves are worth reading despite the sector’s diminutive status.

Consider insight from Bank of America’s August fund manager survey. It queried 247 respondents with a combined $635 billion in assets under management. Those fund managers are underweight equities, but they have been buying stocks in recent weeks. However, they are bearish on REITs.

Bank of America strategist Michael Hartnett noted “capitulation” is showing in REIT positioning. This mirrors levels last seen during the global financial crisis when Lehman Brothers collapsed.

REITs Dichotomy

Calling REITs “fascinating to watch,” Hartnett highlights two potential scenarios. First, if a recession is avoided, establishing long positions in REITs could be rewarded. On the other hand, if the U.S. economy experiences a hard landing and/or slips into a recession, REIT stocks and ETFs could incur more losses.

He added that one of Bank of America’s short-term contrarian trade ideas is for professional investors to be long REITs and short bonds.

In a broad sense, REITs have been confounded by higher interest rates. Real estate ranks as one of the most rate-sensitive sectors. Specific to office REITs – a sub-segment that looms large in many traditional REIT ETFs – that group has been under siege. It’s due to rising vacancies and declining property values in some major U.S. metro areas.

“The median office occupancy rate dropped to 87.4% during the first quarter. That’s the lowest it has been since occupancy rates started declining in 2020. On an annual basis, the median occupancy rate was down 65 basis points and plunged 5.65 percentage points compared to the fourth quarter of 2019, just before the COVID-19 pandemic,” according to S&P Global Market Intelligence.

The combination of higher rates, declining prices, and rising vacancies is expected to spark more sales of commercial real estate in the coming quarters. There could be plenty of willing buyers, as a recent Wall Street Journal article indicates Cohen & Steers, Goldman Sachs, EQT Exeter, and BGO are among the firms raising capital to potentially acquire distressed properties.

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