Real estate investment trusts as measured by the S&P 500 Real Estate Index (NYSEARCA:XLRE) have outstripped the S&P 500’s (SP500) performance over the past couple of months, but Wells Fargo Investment Institute (WFII) said the move wasn’t sufficient reason for it to upgrade the sector out the “unfavorable cellar.”
The S&P 500 Real Estate Index sector climbed ~13% from July 1 through Monday’s session, vs. S&P 500’s (SP500)(SPY) nearly 3% gain. REITs have risen on expectations that interest rate cuts will start this year, which Fed Chair Jerome Powell has confirmed.
“With Fed interest-rate policy likely shifting soon, we have considered lifting Real Estate out of the unfavorable cellar. We have decided not to at this time, though,” John LaForge, head of real asset strategy at WFII, said in a Monday note.
REITs are historically sensitive to interest-rate changes as they need to fund acquisition and development efforts by accessing external capital, and that historical connection prompted WFII in March 2022 to downgrade Real Estate to an unfavorable ranking, it said.
The three reasons why WFII still ranks Real Estate unfavorable relative to other S&P 500 (SP500)(IVV) sectors:
- Low or declining interest rates is not a slam-dunk recipe for REIT outperformance – the relative performance of REITs stayed negative through much of 2020-2022 when interest rates were falling and neared zero
- REITs have shown poor relative strength for years, and “we are not convinced that this long-term trend has changed,” LaForge said. WFII projects U.S. economic growth will continue to decelerate into early 2025
- “If this does occur, we suspect that the more economically sensitive areas like real estate could suffer,” he said.
- LaForge also published a chart showing that in recent years, past-due real estate loans have risen to levels not seen since 2013
“REITs have outperformed in recent months because of the Fed’s potential shift, but we are not yet convinced that the positive performance will last,” LaForge said.
WFII does favor sub-sectors within the Real Estate group that it said are relatively less cyclically sensitive and that are experiencing high demand from thematic trends, such as the adoption of generative artificial intelligence. Those sectors include:
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Data Center REITs
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Industrial REITs
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Self-Storage REITs
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Telecommunications REITs
Year-to-date, the Real Estate Select Sector SPDR ETF (XLRE) has risen 8% vs. the S&P 500’s (SP500)(VOO) increase of 18%.
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