With Q2 Reports Ahead, REIT Outlook Stays Upbeat

NEW YORK CITY—Among the major REITs, Prologis Inc. is slated to kick off the second-quarter round of reporting results with a conference call at 9 a.m. Tuesday. In advance of this report, Barclays Capital provided a forecast for the sector as a whole as well as individual property types, and the outlook is mainly upbeat.

On average, Barclays expects reported Q2 funds from operations per share for its coverage universe to increase 6.5% year-over-year and operating FFO, which excludes non-recurring items, to increase 7.1%. For full-year 2014, “we expect reported FFO ps for our coverage universe to increase 13.9% YOY; on an operating basis, we project a 7.5% increase,” according to the Barclays report.

Barclays notes that REITs have outperformed the S&P 500 by 10.8% year to date, after 31.4% underperformance in 2013. “The question of whether that performance is sustainable has emerged recently, given that REITs are trading at relatively high multiples versus the S&P 500,” the report states.

Although a double-digit second half of the year is unlikely, “we do think REIT stocks will hold onto their gains for the rest of 2014 on strong earnings growth, driven by limited new supply, rental rate growth and our expectation that the Fed will maintain a low interest rate environment. A sharp, unpredicted rise in interest rates remains the key risk.”

On a sector-by-sector basis, Barclays assigns positive outlooks to apartments, industrial and technology, while maintaining a neutral outlook for office and retail REITs—and for the sector as a whole. For multifamily, Barclays says, “With the seasonally stronger spring leasing season complete, we expect management teams to revisit 2014 guidance ranges and look for management commentary regarding 2H14 expectations. We project 4.5% YOY SSNOI growth in 2Q14, driven by 4.1% revenue growth and 3.1% expense growth, resulting in 9.5% operating FFO/share growth.”

In the office sector, Barclays is expecting rents to improve broadly, “driven by modest occupancy gains due to rising employment and still limited new supply.” Development is expected to accelerate in view of “improving fundamentals and dwindling acquisition opportunities” for the office sector.

Steady economic growth, a shift to e-commerce/same-day delivery and acceleration in global trade are driving increased demand for industrial space, and therefore Barclays continues to favor the sector. “Meanwhile, supply remains limited generally to smaller warehouses and the majority of new development is pre-leased.”

For mall REITs, continued releasing spread strength, particularly in class A malls, should help offset concerns surrounding potential lackluster trends in sales per square foot in the year's first half. “For shopping centers, we expect the momentum of small-shop occupancy gains to continue,” according to Barclays, which expects “greater asset consolidation across the industry” for retail on the whole.

In the technology sector, there are signs of contracting supply and improving pricing power, as well as senior leadership updates in focus for the second half of '14. “We expect leasing volume to continue to be relatively robust for the data center REITs fueled by strong demand from cloud providers and IT enterprise outsourcing. While supply has been a concern over the past several quarters, available inventory has been shrinking. We expect this dynamic to be reflected in modest, but improving mid-single digit rental rate growth, particularly for more constrained markets, such as Chicago.”

Barclays says it's updating its discount rate assumptions and rolling its sentiment/regression values forward, “causing our total return assumptions to increase by 4.8%. We now forecast that the group will return 11.9% over the next 12 months, including a 3.1% estimated dividend yield. With the sector at 22.7x 2014E CAD and an implied nominal cap rate of 5.6%, we continue to think that the group is fairly valued.”