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Citi

Adding Allocation to Real Estate Investment Trusts (REITs)

While global equity REITs have recovered significantly since late March, they remain down 20% for the year. Commercial and residential mortgage REITs have fallen nearly 40%, lagging the credit market improvements elsewhere in fixed income.

 

As with other sectors, specific types of REITs have gained sharply, while others have fallen. The winners include “digital disruptors”: cell tower, digital infrastructure, and e-commerce-related logistics REITs. Retailer REITs have fallen nearly 50%, with others moderately impacted between these extremes. Retail REITs were already under secular pressure, and the scope of the COVID-19 shock has worsened their already weak fundamentals. Reduced business travel may also sharply depress hotel industry occupancy.

 

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But many real estate assets are pricing in fairly extreme pessimism amid an environment of sharply lower interest rates, central bank credit easing steps, and an inevitable rebound in social engagement. The economic reopening and resumption of US driving activity to 95% of pre COVID-19 levels may indicate a stronger recovery in property fundamentals than seen in some travel and leisure industry segments.

 

Leveraged residential mortgage REITs and Commercial Mortgage REITs represent another asset class, with various fundamental credit profiles and asset price drivers. While the Federal Reserve is not buying these assets directly, the powerful rise in US corporate bonds of all credit profiles and Agency Mortgage Backed Securities suggests that easing may benefit this asset class as well. US Treasury yields could rise moderately at the long end of the curve, but tighter credit spreads and potentially recovering asset prices may boost returns.

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