“I think that the movement out of the REITs because of rising interest rates has been sort of overdone, which is why we think all the names are trading at basically a 20% discount to our fair value estimate,” Brown noted in a recent interview. Fair market value, he noted, is the level Morningstar’s analysts forecast companies will reach in three to five years.
In comparison to the Morningstar U.S. Market Index, which fell by 7.5% through Friday’s close, the firm’s real estate index was down 3.7% during the previous 12 months. However, Brown pointed out that while the market index is unchanged over the preceding three months, the real estate index is down 3.5%.
While share prices may be down, he said the bulk of REITs are generating growth substantially above historical averages and REIT sector operations – including businesses with a focus on self-storage facilities, hotels, healthcare facilities, apartment buildings, single-family rental homes, malls, and shopping centers – are generally thriving.
Since rents are high, REITs in many property sectors have transformed single- and low-double-digit net operating income growth into gains of 15% to 20%; occupancy is reportedly sitting at peak levels, and the businesses have done a good job controlling expenses. Second-quarter earnings reports have shown numbers that are significantly higher than expected.
REIT prices would likely underperform the rest of the market if interest rates kept rising, according to Brown, but this underperformance will correct itself and shares will eventually return to their long-term valuations.