REITs Counter Fed Suspense, Q2 Earnings in Focus

The real estate investment trust (REIT) sector is somewhat jittery due to the Fed's interest rate indecision, but offers some good investment opportunities thanks to demand growth. In fact, REITs have returned more than the broader market in the first half of the year.   

The total FTSE NAREIT All REITs Index returned 18.24% compared with the 8.22% gain for the S&P 500 Index as of Jul 18. This outperformance was backed by a notable drop in Treasury yields, continuation of the low interest rate environment and a comparatively lower level of new supply of real estates.

How Was the Sector Backdrop in Q2?

Leaving behind the winter issues that snowballed into high property costs in the first quarter, the focus turned to the demand side of real estate in the second quarter. Favorable demographics and e-commerce applications lent enough support to this demand growth.

And the sluggish pace of economic recovery was a blessing in disguise as supply of new constructions remained modest. This gave the present real estate owners a solid scope to capitalize on.

A recent report from CBRE Group Inc. CBG also supports our view.  The report highlights a decent recovery in the fundamentals of a number of real estate types in the second quarter. The office vacancy rate slipped 30 basis points (bps) to 14.5% in particular, following a 10 bps decline in Q1. This was propelled by growth in private sector jobs.

National industrial availability fell 30 bps from the prior quarter to 10.8% with e-commerce being a driving factor. Moreover, apartment demand continued to increase, with vacancy rate of 4.4% declining 20 bps year over year. Also, the retail availability rate declined 20 bps from the prior quarter to 11.7%.

Obviously, a decline in vacancy levels essentially reflects the rising demand for space and is, therefore, a positive sign for the industry's growth.

But Worries Still Exist

Despite this healthy recovery in fundamentals, a number of markets still look stretched. For the hotel/lodging REITs, the West Coast market continues to offer promises, while the East Coast remains a drag with bleak chances of recovery.

In addition, leasing pace is sluggish in the Washington, D.C. office market. The employment level in this market continues to depend on government-related and legal industries in which a sheer lack of job demand prevails.

There Are Still Opportunities  

Nevertheless, hurt by taper and interest rate issues in the past, the healthcare REIT valuations look cheap and offer a good entry point. Moreover, as short-term interest rates are likely to remain low with the Fed stance, we believe that mortgage REITs will benefit as long as interest spread remains wide.

Earnings of Top REITs in Focus

According to the Zacks methodology, a stock needs to have both a positive Earnings ESP and a Zacks Rank #3 (Hold) or better for an earnings surprise.

Earnings ESP is our proprietary methodology for identifying stocks that have the best chance to surprise with their upcoming earnings announcements. It shows the percentage difference between the Most Accurate estimate and the Zacks Consensus Estimate. Our research shows that for stocks with this combination, the chance of a positive earnings surprise is as high as 70%.

Here's how some of the top REITs are expected to report:

Host Hotels & Resorts, Inc. HST

Based in Bethesda, MD, this Zacks Rank #2 (Buy) hotel REIT stock is scheduled to release Q2 earnings on Jul 31, before the opening bell.

Zacks Consensus Estimate (funds from operations or FFO per share): 43 cents
Zacks Consensus Estimate (revenue): $1.4 billion
Earnings ESP: 2.33%

This combination of Zacks Rank and Earnings ESP conclusively show that Host Hotels has a chance to beat the Zacks Consensus Estimate.

American Capital Agency Corp. AGNC

This Zacks Rank #1 (Strong Buy) mREIT company, also based in Bethesda, MD, is scheduled to release its Q2 earnings on Jul 28, after the market close.

Zacks Consensus Estimate (earnings per share): 66 cents
Zacks Consensus Estimate (revenue): $304 million
Earnings ESP: 6.06%

This combination of Zacks Rank and Earnings ESP conclusively show that American Capital Agency might exceed the Zacks Consensus Estimate.

Essex Property Trust Inc. ESS

With a Zacks Rank #3, this Palo Alto, California-based company is a residential REIT scheduled to report second-quarter earnings after the market closes on Aug 6.

Zacks Consensus Estimate (FFO per share): $1.67
Zacks Consensus Estimate (revenue): $258 million
Earnings ESP: 7.19%

With this stock's combination of Zacks Rank and ESP we can say that Essex has a chance to beat the Zacks Consensus Estimate.

Then Again…

Kimco Realty Corporation KIM

This New Hyde Park, New York-based Zacks Rank #3 company is scheduled to release Q2 results on Jul 29, after the market close.

Zacks Consensus Estimate (FFO per share): 34 cents
Zacks Consensus Estimate (revenue): $239 million
Earnings ESP: 0.00%

We cannot conclusively say that Kimco will beat the Zacks Consensus Estimate. Though the company's Zacks Rank #3 increases the predictive power of ESP, we also need to have a positive ESP to be confident of an earnings surprise call.

Boston Properties Inc. BXP

This Massachusetts-based Zacks Rank #3 company is scheduled to release its Q2 results after the market close on Jul 29.

Zacks Consensus Estimate (FFO per share): $1.33
Zacks Consensus Estimate (revenue): $566 million
Earnings ESP: 0.00%

Here also, we are not confident of an earnings beat as Boston Properties does not have the right combination Zacks Rank and Earnings ESP.

Bottom Line

An earnings beat essentially lifts investors confidence on the stock and immediately leads to stock price appreciation. This when supported by improving fundamentals in the REIT industry can prove rewarding for investors. Hence, tracking such stocks and prudently investing in these might fetch decent returns.

For that, keep an eye on our earnings preview and earnings report coverage in the coming days on www.zacks.com.

Note: FFO, a widely used metric to gauge the performance of REITs, is obtained after adding depreciation and amortization and other non-cash expenses to net income.