What to Expect in the REIT Market in 2019

Calvin Schnure and Brad Case, economists at Nareit, this week published their outlooks for the U.S. economy and for the REIT market in 2019.

Schnure, senior vice president for research and economic analysis, downplays concerns about a major economic slowdown, and makes the case that solid fundamentals will provide the impetus for the economy and the real estate market to keep growing.

He sees a likely slowing of GDP growth, but not a sharp letup given healthy business activity and consumer demand that can handle moderately higher interest rates. He puts the odds of slowing to less than 2.5% at 20%, slight easing to between 2.5% and 3% at 60% and accelerating above 3% at 20%.

He notes, however, that energy prices and trade wars are wildcards.

Inflation, according to Schnure, is likely to rise only between 1.7% and 2.2% by the end of 2019, which would be in line with the Federal Reserve's target.

He says there is a seven in 10 chance that the Fed will limit itself to just one more rate increase in 2019, likely in the first half of the year. This will result in a federal funds rate of 2.75% or less by year-end.

Schnure sees a 50% chance that long-term interest rates will end the year at between 3.25% and 3.75%. "Even with modest increases, these financing rates are still low and are favorable for real estate," he says.

"The next year is likely to be a good but not great one for real estate, with solid job growth, consumer spending and business activity driving demand for nearly all types of commercial real estate."

REIT Outlook

Case, senior vice president for research and industry information, ascribes REITs' underperformance over the past two years not to the effect of interest rates on real estate values, but to what he says was "irrational exuberance" about future earnings growth for already-overvalued companies, especially tech companies.

He says there were two important developments in the REIT market last year: the end of a tech stock "bubblet" and the beginning of a rediscovery of companies with more favorable valuations, including REITs.

According to Case, REITs held their own during most of 2018 as investors came to terms with fundamental market conditions and began to shift from a bubble mentality toward a value-seeking mentality.

Investors that had been preoccupied with tech stocks, private equity and private-equity real estate eventually saw favorable opportunities in REITs, which had become one of the most undervalued segments of the investment market. In mid-October, the long-delayed reversion in relative valuations finally began, according to Case.

He says the strong operating environment for REITs will continue in 2019 and for several years to come. Net operating income from REIT-owned properties has continued to grow at a strong, sustainable rate. The pace of new construction remains below the level of just over 1.5% of GDP that was normal before the construction collapse that began in 2008.

Moreover, the average occupancy rate at REIT-owned properties has increased 30 basis points from a year ago to 94.29% — the highest average ever recorded in a Nareit data series going back to the first quarter of 2000. And the occupancy rate for REIT-owned retail properties is even higher at 95.43%.

On top of this, Case says, "REITs have managed their balance sheets prudently, ensuring that they will be able to access the capital markets on favorable terms when they identify opportunities to create value."

— Check out 5 Predictions for the Housing Market in 2019 on ThinkAdvisor.