Retail sales data came in this morning. American consumer spending, it turns out, was up 1% month-over-month. “Hotter than expected” is the term of the day.
Markets were certainly happy with the news. All three major American indices opened higher, with the techs over in the Nasdaq leading the way.
After years of anticipation, investors are now virtually certain: Jay Powell finally has all the cover he needs. Rate cuts are coming. It’s just a matter of by how much at a time.
A quick look at the CME FedWatch tool – which shows the market’s expectations of future Fed policy – would seem to confirm that.
The futures market is implying a 72.5% probability for a quarter-point cut at the September meeting. Interestingly, a 50-basis point cut is also in the cards. More importantly, there is now zero expectation that rates will remain steady.
That can always change, but it’s looking more and more certain that it’s time to ease. And once that happens, it will light a fire under an asset class I know very well. One that has struggled in this high-rate environment, but is now a coiled spring.
The rebound in commercial real estate – and the best-managed real estate investment trusts (REITs) – is now at hand.
Every Once in a While…
The real estate sector has underperformed in recent years. The Vanguard Real Estate Index Fund ETF (VNQ) fell by as much as 38% between January of 2022 and October of 2023.
That’s a bear market. No doubt about it. The table below should give you some idea of how tough it’s been for real estate.
What you’re looking at is the various sectors of the S&P 500 and their performance in a given year. And what I’d draw your attention to is the real estate sector in pink.
2020 was a tough year for real estate, down about 2% in the wake of lockdowns and the “work from home” trend. The asset class did come roaring back in 2021, printing 46% returns. But then came 2022.
Real estate once again fell, producing -26% returns. And even though the sector has rebounded slightly since, it’s still way behind tech, communication services, and consumer discretionary – the top three sectors from last year.
I spent much of my career as a real estate developer. So, I’m intimately familiar with the real estate cycle. You don’t want to get caught at the top of it as I did during the 2008 crisis.
But buying premiere real estate assets at the bottom of that cycle? Now, that can be a generational opportunity.
For instance, most people remember the real estate disaster that unfolded in 2008. But what few know is that the S&P 500 real estate sector was the fourth-best of 2009, up 27%. And in 2010, it came out on top, printing a 32% return. Then it did it yet again in 2014, posting 30.2% returns that year.
This doesn’t happen often. But every once in a while, investors have the opportunity to buy these assets at temporarily discounted prices and reap the rewards. That’s the opportunity I see today.
In fact, the turnaround is already happening.
Investors Won’t Wait
Real estate – as an asset class – is very sensitive to interest rates. That’s why the higher rates of recent years have been a headwind. But as rates fall, this force will become a tailwind.
Likely a powerful one, at that.
Markets are always forward-looking. And if rates will fall in the next few months, you might as well buy real estate assets now. That’s what investors are doing.
In the past month, we’ve seen the sentiment surrounding REITs begin to shift in the markets. The Vanguard Real Estate Index Fund ETF (VNQ) is up by more than 4.3% during the last month. The S&P 500, meanwhile, is down about 2%.
Many individual REITs, meanwhile, have done much better. Some of our favorite stocks from the sector are up double digits from recent lows.
I don’t see this slowing any time soon. Negative sentiment can linger around an asset class for months or even years. But eventually, fundamentals force the market to take another look. After all, markets are a weighing machine in the long-term.
Right now, we have nine holdings in our REIT Portfolio at Wide Moat Research. And they’ve been holding up nicely:
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Eight out of the nine posted positive bottom-line growth last year.
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Eight are expected to post positive bottom-line growth this year.
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And we expect all nine to post positive bottom-line growth next year.
With that in mind, you shouldn’t be surprised to hear that every one of them raised their dividend last year. Or that this trend is expected to hold true this year as well.
Now’s also probably a good time to mention that we’ve never experienced a dividend cut in our Wide Moat REIT Portfolio.
Bottom line: The market has all but forgotten about commercial real estate since rates began moving higher… completely ignoring how some of the best-managed publicly traded landlords continue to raise dividends and grow their cash flows.
This has gone on for a long time. But we all know it can’t go on forever. And I think we’re very close to seeing the economic winds shift in our favor.
I’ve said it before, and it’s worth saying again. The rebound in commercial real estate is close at hand. In fact, it’s already begun.
Break out your shopping list.
That’s what we’ll be doing here at Wide Moat Research.
Regards,
Brad Thomas
Editor, Wide Moat Daily