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Andrew Demand: I’m Andrew Demand, Vice President of Portfolio Management here at Sage. Today we are going to talk about a Credit sector that has delivered almost 60 bps of excess performance relative to the broad credit index year to date: REITs.
REITs have approximately 30 bps of excess return this year vs the aggregate index, whereas the general credit index has delivered negative 28 bps of excess return. Today we are going to address 3 of the main drivers of this performance and what opportunities remain in the REIT space.
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The first driver I want to talk about is the Quality of the balance. A theme that has been garnering much attention in the credit space is how companies have been allowing the leverage of their balance sheets to creep up over the last few years. This has not been the case in the REIT Sector however. Leverage is down year over year in the space. Cap rates on properties have been low and property prices have been high. Causing REITs to focus on depositions of assets and fortifying their balance sheets. A trend that is contrary to what is going on in the credit space. This has been reflected in the rating agencies actions as well. There have been 38 ratings actions in the IG REIT space year to date and 26 of them have been positive. REITs have been rewarded this year for their improved balance sheets as well as their positive ratings momentum.
The second driver of performance has been Issuance, or rather the lack there of. We are almost three quarters through the year and REITs have raised approximately $20 billion in debt vs the $55 Billion that REITs raised last year. We are well behind the pace of last year for issuance. Many companies have used recent issuance to take out front end debt, thus going forward we expect the need for issuance to be muted. Without new issuance the demand for existing bonds has remained strong.
Lastly the reach for yield has helped REITs deliver positive performance. REITs have and continue to trade wide, or cheap, to the corporate bond index, despite Improving balance sheets and lack of issuance. This has made REITs look attractive.
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So what opportunities still exist?
In general we believe that REITs can still offer attractive value here. We expect their positive ratings momentum and lack of issuance should continue to drive performance in the short term.
In particular we find that retail REITs can offer attractive risk reward characteristics here. In the retail space you read headlines about Amazon and the Death of the brick and mortar store, and this has led to overreactions to anything branded with the word “retail.” It is true that many stores are struggling as a result of the growing online retail business; however not all retail is the same. Many retail REITs have specialty focuses that have allowed them to largely avoid the worst of the so-called “retail apocalypse.”
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For instance, National Retail Properties, ticker NNN, focuses on single ternate retail spaces. They have large exposure to convenience stores, auto servicing facilities, family entertainment, and health and fitness centers, which are areas that are somewhat insulated from the growing online retail business. Other retail REITS that have shown bottom-line success are focused on grocery store-anchored shopping centers, pharmacies and other business that don’t sell products that are easily transferable into the online retail model.
On top of that, management teams of REITs actively manage their portfolios. They can step in to update facilities that are losing popularity or even dispose of their non-performing assets before the problems get too big. Many of the Retail REITs have consistently delivered strong performance by focusing on specific segments of the retail market, as well as actively managing their property portfolios. This has led to positive ratings momentum for certain REITs and has created opportunities for investors.
Disclosures: Sage Advisory Services is a registered investment adviser that provides investment management services for a variety of institutions and high net worth individuals. This podcast is for informational purposes only and is not intended as investment advice or an offer or solicitation with respect to the purchase or sale of any security, strategy or investment product. Investors should make their own decisions on investment strategies based on their specific investment objectives and financial circumstances. All investments contain risk and may lose value. Past performance is not a guarantee of future results. For additional information on Sage and its investment management services, please view our web site at sageadvisory.com, or refer to our Form ADV, which is available upon request by calling 512.327.5530.
