REIT Commentary – June 2018

Hand drawing with chalk money earning strategy

The MSCI US REIT Index (RMS) had a total return of +4.4% in June, while the S&P 500 had a total return of +0.6%. The Chilton REIT Composite underperformed the benchmark for the month by producing a total return of +4.3%, both net and gross of fees. For the second quarter, the Composite produced a total return of +6.9% net of fees and +7.1% gross of fees, which compared to the RMS at +10.1%. Year to date, the Composite has produced a total return of -1.7% net of fees and -1.3% gross of fees, which compares to +1.2% for the RMS.
Year to date, the largest detractors to relative performance were stock selection within the shopping center, regional mall, and office sectors. Stock selection within the diversified and data center/tech sectors, as well as an underweight allocation to triple net REITs contributed to relative performance.

YTD Detractors Summary

  • Owning Whitestone REIT (NYSE: WSR) within the shopping center sector detracted from the composite’s relative performance due to the company missing first quarter earnings estimates and a heated proxy fight. Earlier this year, we lost confidence in management’s strategy and ability to create value for shareholders. We no longer hold a position in WSR. Within the sector, we favor REITs with exposure to high-quality grocery-anchored centers that should be less sensitive to e-commerce competition due to their focus on necessities and everyday services.
  • Owning Macerich (NYSE: MAC) within the regional mall sector detracted from the composite’s relative performance. Speculation has surrounded Macerich as an M&A target due to its discounted valuation, high-quality portfolio, and numerous activist shareholders such as Land and Buildings, Starboard Value, and Third Point. However, Third Point exited its position in MAC in in the first quarter, which could explain some of the company’s relative underperformance. We continue to favor Class A mall REITs over Class B mall REITs within the sector. Class A malls that provide consumers with unique experiences and quality tenant lineups should continue to maintain sector leading occupancy and weather any competitive threats from the internet. Additionally, the possibility of getting back space from struggling tenants is viewed as an opportunity for Class A mall REITs to upgrade the tenant mix at higher rents.
  • Owning Empire State Realty Trust (NYSE: ESRT) within the office sector detracted from our relative performance. Companies with exposure to New York City have underperformed due to supply concerns and a lack of new leasing. However, we believe our holdings within the office sector are poised to deliver strong earnings growth in 2019 and beyond due to development/redevelopment that is not properly reflected in their stock prices.

YTD Contributors Summary

  • Owning Armada Hoffler (NYSE: AHH) contributed to our relative performance within the diversified sector. AHH owns a diversified portfolio of high-quality office, retail, and apartment properties primarily in the Mid-Atlantic region. AHH’s accretive development pipeline should lead to outsized NAV growth over the next couple years.
  • Our allocation to tower REITs with the data center/tech sector contributed to the Composite’s relative performance. Tower REITs look to be the beneficiaries of carriers deploying recently acquired spectrum, the rapid increase in mobile data usage, and the expansion of small cell sites which are helping carriers meet insatiable demand in urban areas. Data center REITs will continue to benefit from increased corporate data outsourcing, the growth of the ‘cloud’, and the need for speedy delivery of data.
  • An underweight allocation to the triple net sector (0% allocation) contributed to the Composite’s relative performance. Triple net REITs continue to be one of the most correlated to interest rates due to its similarity to fixed income. We favor sectors with more attractive growth profiles.

Monthly Attribution

June results underperformed the benchmark due to underweight allocations to the healthcare and self storage sectors, as well as stock selection within the diversified sector. Contributors to relative performance included an underweight allocation to the lodging sector, an overweight allocation to the data center/tech sector, and stock selection within regional mall REITs.

Market Commentary

We came back from New York with a positive view on the sector as a whole, reassured that the negative performance in the first two months of the year was merely a bet on interest rates, and not evident of any degradation in REIT fundamentals. The strength in the economy, supported by consumer and corporate spending increases thanks to tax reform, has begun to filter through to the tenants of the REITs, most notably in the retail and residential sectors. With the recent drop in the 10 yr US Treasury yield to 2.8%, we revise our total return outlook for the year to +4-6%, assuming a steady 10 yr US Treasury yield and further dividend increases as REITs deliver cash flow results above prior guidance over the next several quarters. This would imply a +3-5% total return in the second half of the year.

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