23 September 2018

Real Estate Stocks Loose Luster

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The Federal Reserve’s hawkish tilt is upending real-estate investment trusts and other stocks with juicy dividend yields that had been thriving in a lower interest-rate environment.

S&P 500 real-estate stocks fell 1.2% last week, hurt by the Fed’s decision to lift interest rates on Wednesday and its signal that the bank could pick up the pace of future rate increases. Those real-estate shares are down 4.3% for the year, among the worst performances of any S&P sector and well below the broader index’s gain of 4%.

REITs’ underperformance is another sign of how the Fed’s response to a strengthening economy is rippling through the stock market.

Investors often buy shares of real-estate firms and other stocks like utilities for safe, bondlike returns. But as the Fed accelerates the pace of policy-tightening, the payouts on U.S. government bonds are rising and forcing investors to consider whether they are better off shifting money into bonds that are poised to see higher yields. The Fed plans to increase rates two more times this year, eventually pushing the fed-funds rate to a range of 3.25% to 3.5% by the end of 2020.

“We’re at the point where interest rates are starting to actively compete with high dividend yielding stocks for investors’ dollars,” said Steven Violin, senior vice president and portfolio manager with F.L. Putnam Investment Management Co., a firm that manages about $1.7 billion in assets.

The yield on the benchmark 10-year U.S. Treasury note briefly rose above 3% after the Fed’s decision Wednesday and continues to hover around that level. That is just below the 3.1% dividend yield offered by real-estate stocks in the S&P 500, which is among the highest in the index.

Wells Fargo recently downgraded its outlook on the real-estate sector. In a research report, John LaForge, head of real asset strategy at Wells Fargo Investment Institute, said real-estate investment trust “performance often moves in an opposite direction from interest rates.” REITs were also hit hard by the February spike in 10-year Treasury yields.

Real-estate stocks in the S&P 500 have risen the last four years, when interest rates were at or near zero, and posted a 7.2% gain in 2017.

Wells Fargo says the average REIT trades at a roughly 7% discount to its underlying real-estate holdings, keeping valuations relatively attractive since such investments have averaged a 2.3% premium since 1990. Appealing valuations kept Wells Fargo from downgrading the sector beyond neutral, the bank added in its note.

Commercial real-estate prices have also been steadily gaining, providing some support to the sector amid the changing interest-rate environment. The Green Street Commercial Property Price Index, for example, has steadily risen since 2010.

Fund managers who actively manage their portfolios have already cut exposure to the real-estate sector to a six-month low, according to a Bank of America Merrill Lynch report.

Investors pulled another $71.8 million in the last week from the Vanguard Real Estate exchange-traded fund, bringing the roughly $30 billion fund’s total outflows this year to $2.6 billion, according to FactSet.

Utility stocks, which also generate hefty dividends and tend to underperform in rising-rate environments, are also struggling, falling 6.7% so far this year. Of the 11 major S&P 500 sectors, active managers have the least exposure to utility and real estate, Bank of America Merrill Lynch said in its report. Utility ETFs managed by State Street Global Advisors, Vanguard Group, BlackRock and Fidelity Investments have all suffered outflows so far this year, according to FactSet’s data.

Rising interest rates aren’t necessarily bad news for stock investors. Shares of financial firms such as banks tend to benefit when interest rates rise because it makes their lending operations more profitable. The KBW Bank Index, which includes 24 different banks including large lenders like Bank of America Corp. and smaller firms likeKeyCorp and Comerica Inc., is up 1% so far this year.

Shares of consumer-staple companies, which have struggled lately with trade tensions, rising costs and shifting consumer preferences, are also getting more interest from investors lately. Active fund managers have upped their exposure to the sector for four months running, Bank of America Merrill Lynch said, a defensive posturing in the current environment since those stocks sell everyday essentials like food and beverages that tend to do well in the latter stages of an economic cycle.

Retail investors are taking notice too, and have contributed to the $219 million that has flowed into the Consumer Staples Select Sector SPDR fund, FactSet said.

Click here for the original article from The Wall Street Journal.

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