Winners and Losers in REITs' Q3 Results

NEW YORK CITY—REIT earnings season for the third quarter is just about at the halfway mark, with such sector leaders as Equity Residential, Prologis, SL Green Realty Corp., AvalonBay Communities and Ventas Inc. all reporting strong results. That small sampling of more than 175 publicly traded companies is both a summary of what we can expect from this earnings season and not representative of the whole, according to a Jefferies and Co. report.

Although the Q3 announcements coming out between Oct. 15 and Nov. 10 should yield results primarily in line with analysts' expectations, “there will be more positive and negative outliers,” writes Jefferies equity analyst Omotayo Okusanya. On the negative side, according to Okusanya, “we have rising supply issues in certain property types (senior housing, select service hotels) and a weaker tourist market due to a strong dollar impacting hotels and malls in key tourist markets. On the positive side, we continue to see strong fundamentals in storage, apartments, data centers and CBD office.”

Multifamily and storage REITs in fact get the highest marks from Jefferies analysts. For apartments, Okusanya writes, fundamentals remain “robust' while management teams are “very bullish,” a combination that he elives will lead to Q3 earnings largely beating consensus estimates.

In the storage sector, “occupancies and effective rental rates keep rising while the pace of acquisitions remains strong,” writes Okusanya. His summary of Q3 earnings cites expectations of year-over-year occupancy gains of between 50 and 150 basis points. Similarly, Jefferies analysts expects same-store NOI growth “in the mid- to high-single-digits,” with Extra Space Storage and CubeSmart coming in at the high end of the range.

Storage is seen as one of two REIT sectors most likely to see increases in guidance on funds from operations; the other is data centers. “In the data center space, channel checks suggest solid leasing velocity and pricing trends—especially for colocation and interconnection facilities,” writes Okusanya.

Conversely, he writes, “we worry somewhat about healthcare given soft seniors housing operating trends” this past quarter. In an earlier report, Okusanya cited data from the National Investment Center for Seniors Housing and Care showing that new supply as a percentage of inventory is climbing, especially in the assisted living space. Despite stable operating trends in Q3, Jefferies is lowering its outlook for healthcare REITs with a strong concentration in seniors housing.

Although class A retail continues to be solid, “class B and below still feels challenged given lack of retailer demand and tightening lending standards,” Okusanya writes. He predicts that hotel REITs 'will remain under pressure following a rough start to earnings last week.” A sector-by-sector chart included in the Jefferies report notes that lodging REITs currently trade as the steepest discount to NAV, 18.7%, especially when compared to the sector's five-year and 10-year averages.

Given a “meaningful” discount to NAV for REIT stocks generally, and given the substantial war chests that private equity firms have built up, management's earnings call comments on possible M&A “will be closely watched given the recent string of take-outs in the sector,” writes Okusanya. The month of October has seen Lone Star Funds complete its privatization of Home Properties, the Blackstone Group agree to acquire BioMed Realty Trust, Campus Crest Communities sell to Harrison Street Real Estate Capital and, most recently, Landmark Apartment Trust trade to Starwood Capital Group. In September, Blackstone inked an agreement to take another REIT private, Strategic Hotels & Resorts.

“Investors are wondering who might be next and will likely home in on some of the lodging, office and retail REITs that trade at significant discounts to NAV,” writes Okusanya. “With several names trading at NAV discounts, capital allocation will also be a major topic of conversation especially around buybacks, asset sales, leverage and funding developments/acquisitions.” He notes that this applies especially to companies suffering from "an equity overhang due to over-reliance on their lines of credit.”