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REITs Back in Favor as Rate Path Becomes Clear

The return of growth stocks has been the story to start the new year, but another area that often gets overlooked during bullish periods are real estate investment trusts (REITs). Like growth stocks, REITs were decimated last year as the Fed embarked upon an aggressive rate-hiking scheme. Combined with prospects of an impending economic slowdown, REITs suffered their worst year in more than a decade.

This has created a phenomenal opportunity to buy these undervalued, oft-forgotten investment vehicles, as the path of future interest rates has reversed course. As per the Wall Street Journal, the Fed’s preferred medium, officials are preparing to slow interest rate increases for the second straight meeting after gaining more clarity that inflation will continue to ease this year. An outright pause may be in the cards as early as this spring, with rates set to fall in the years ahead.

REITs tend to outperform when interest rates are falling, historically generating strong returns when the Fed becomes more dovish. All else being equal, lower interest rates tend to increase the value of properties and decrease REIT borrowing costs. Furthermore, lower rates make the relatively high dividend yields generated by REITs more attractive, increasing their appeal to income-seeking investors.

Adding these incoming-producing investments can result in significant advantages over traditional real estate investing including increased liquidity, greater diversification, tax benefits and potentially higher returns with lower risk.

Real estate investment trusts either own or manage income-producing real estate, normally through directly investing in properties or the mortgages on those properties. The IRS mandates that REITs must pay out 90% of their taxable income to shareholders. This typically translates into much higher dividends than your average S&P 500 stock. One of the best ways to increase returns when investing in REITs is to compound the dividends received. Investors may also choose to utilize a Dividend Reinvestment Plan (DRIP), which automatically reinvests the dividends received into additional shares.

The Zacks REIT and Equity Trust – Retail industry has outperformed the market over the past three months, making a series of higher highs and returning more than 23%:

Zacks Investment Research
Zacks Investment Research

Image Source: Zacks Investment Research

Despite the impressive performance, this group remains relatively undervalued:

Zacks Investment Research
Zacks Investment Research

Image Source: Zacks Investment Research

Let’s take a closer look at an individual REIT within this outperforming industry group.

Equinix (EQIX)

Equinix is a digital infrastructure company that enables leaders to harness a trusted platform to bring together industry-leading organizations. EQIX is a specialty REIT that was founded as a multitenant data center provider. The company focuses on providing a competitive advantage across clouds, networking, storage, and software.

EQIX operates nearly 250 data centers in 71 global markets across 32 countries. Its business is based on a recurring revenue model in which customers are billed at fixed rates through the life of respective contracts, generally ranging from 1 to 3 years. As we can see, earnings and revenue growth have remained steady:

Zacks Investment Research
Zacks Investment Research

Image Source: Zacks Investment Research

For the fourth quarter, analysts expect EQIX to have delivered EPS of $6.84/share, translating to growth of nearly 10% versus the same quarter in the prior year. Revenues are projected to have risen 9.14% to $1.86 billion during the quarter.

What the Zacks Model Unveils

The Zacks Earnings ESP (Expected Surprise Prediction) seeks to find companies that have recently witnessed positive earnings estimate revision activity. This technique has proven quite useful for finding earnings surprises – in fact, when combining a Zacks #3 ranking or better and a positive earnings ESP, stocks have produced a positive surprise 70% of the time.

EQIX is currently showing a positive ESP at 0.54%. Combined with a Zacks Rank #3 (Hold) rating, another earnings beat may be in the cards when EQIX reports fourth-quarter results on February 15th.

REITs not only offer above-average yields, but also the potential for future price appreciation. Make sure to keep an eye on EQIX as well as the general REIT space as the group looks primed for a period of outperformance.

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Zacks Investment Research