A Huge Win for the Donald. 2016 has turned out to be annus horribilis for establishment politics and politicians as well as pollsters who have repeatedly underestimated global populist discontent, which discontent found an unlikely champion in the US in a billionaire prone to tweeting late into the night. Perhaps even more unexpected than the election results was the reaction of the capital markets subsequent; huge losses in the futures markets were quickly reversed and all facets of a “reflation” trade came on display: small caps, cyclicals and financials up, bond yields up and the dollar up.
While the President elect would probably like to take all the credit for the animal spirits awakened, in reality, the US economy was already showing signs of life and, at close to full employment, wage/inflation pressures were being felt even before the election. With the FOMC at the forefront of tighter monetary policy, not only was the yield on the 10-year Treasury Note rising but the yield differential to global counterparts meant that the dollar was strengthening. Only the equity markets seemed uncertain about the balance between a stronger economy and the deleterious effects of rising rates; when Trump won the election, the promise of pro-business policies of deregulation, tax cuts and fiscal stimulus was like gasoline poured on tinder and equities were off to the races.
The Wilshire US REIT Index (“Index”) delivered a total return of -2.3% in Fourth Quarter, underperforming both the S&P 500 and Russell 2000 Indices which advanced 3.8% and 8.8%, respectively. For the year, the Index delivered total returns of 7.3% compared to 12.0% and 21.3% for the S&P 500 and Russell 2000 Indices. Since the GFC, this is only the second calendar year that the Index has underperformed its equity counterparts.
Not All REITs are Created Equal in a Reflationary World. The duration of the lease terms was the most important variable in determining Fourth Quarter relative performance by property type. Hotels were the clear beneficiaries of renewed optimism and investors bid up the stocks despite deteriorating fundamentals reported during Third Quarter earnings and problems in two of the major REIT markets for 2017; New York City (supply) and San Francisco (renovation at the Moscone Center). Conversely, Health Care and Net Lease woefully underperformed during the quarter as investors fled interest rate sensitivity.
Interestingly, Retail continues to suffer in performance. Historically, Retail landlords were thought to be beneficiaries of a better economy and higher retail sales: Regional Malls (lower occupancy costs and higher percentage rents), Power Centers (better credit profile for the tenants) and Grocery anchored Neighborhood Centers (higher rents from in-line tenants) generally have outperformed during periods of good GDP growth but fears of a secular decline vis a vis internet retail and obsolescence of the anchor store as exemplified by problems at Sears and the pulled Neiman Marcus IPO have scared buyers away. With Retail landlords trading at meaningful discounts to Net Asset Values, investors may be underestimating prospects for bricks and mortar, especially at the higher end of sales productivity.