REITs outperform in a volatile quarter. Leading into the final round of the 2016 US Open, Dustin Johnson, the eventual champion, was asked about the disastrous three-putt on the final hole of last year’s US Open which cost him that tournament, to which he replied with aplomb, “What happened last year?” If Dustin Johnson was asked about the global economy in Second Quarter, he might have answered, “What happened in the UK?”
Prior to the tumult surrounding the Brexit vote, the financial markets in the US were performing a delicate pas de deux with the Federal Open Markets Committee (“FOMC”). A Good jobs report and Chairman Yellen would assuage the markets that the path to higher interest rates would be gradual; a bad jobs report and Chairman Yellen would say that growth was still on track and that she was ready to fight inflation. With the Brexit vote, the Kabuki Theater starring the FOMC troupe closed for the year; the 10-Year Treasury note yield collapsed from 1.786% to 1.488% during the quarter.
The Wilshire US REIT Index (“Index”) delivered a total return of 5.6% in Second Quarter, outperforming both the S&P 500 and the Russell 2000 Indices which advanced 2.5% and 3.8%, respectively. The vast majority of the constituents in the Wilshire US REIT Index produced positive returns (87 out of the 116 constituents) but there was significant dispersion in total returns with the best performing REIT, NexPoint Residential Trust Inc., returning 40.9% compared to -22.7% for the worst, Felcor Lodging Trust Inc.
Interest rate sensitive sectors outperform. Given the plunging 10-Year Treasury note yield, it is not surprising that the interest rate sensitive sectors in the Index like Manufactured Housing, Health Care and Factory Outlet vastly outperformed the cyclical sectors like Apartments and Hotel during the quarter. Even within Office and Retail, Suburban outperformed CBD and Strips outperformed Malls. This type of dispersion between property types is very similar to what occurred in the fall of 2012/spring of 2013, the last time there was a sharp decline in interest rates in the US.
What is different this time around is the emergence of secular growth sectors: Self Storage, Data Centers and, lately, Industrial, all to greater or lesser extent stories of technological disruption. The latest iteration of that meme is the Industrial sector whose landlords are seeing significant uptick in demand for both first generation and second generation space by internet retailers. In a “lower for longer” world of interest rates and returns, shares in companies and property types that can demonstrate growth are being bought by investors at any price.