The first four months of this year were not favorable for the overall U.S. real estate investment trust (REIT) industry. Uncertainty and restrained trading activity took a toll on returns.

The FTSE/NAREIT All REITs Index registered a total return of 3.5% in the first four months of 2017, lagging the S&P 500’s stellar 7.2%. Specifically, Equity REITs, which comprised a majority of the total REIT market, came up with a weak performance, with the FTSE NAREIT All Equity REITs Index finishing April with a total return of 2.99%.

Admittedly, the concerns surrounding rate hikes and movements of treasury yields made investors skeptical about investing in REIT stocks. This is because REITs are typically dependent on debt for their business. Also, they are often considered as bond substitutes for their high and consistent dividend-paying nature. Apart from these, fundamentals of some of the underlying asset categories provided headwinds and drove away gains.

Particularly, the retail REIT segment felt the heat with dwindling traffic and store closures amid aggressive growth in online sales, which checkered demand for the retail real estate space. Also, an increasing number of deliveries of new units in a number of key markets and elevated concession activity raised concerns over some apartment REIT stocks.

But sidelining the entire industry would not be prudent, as REITs cater to a wide range of real estate assets and each asset category has its own demand-supply dynamics.

In the first four months of 2017, even though the overall returns from the REIT industry fell short of the broader market, a number of asset categories showed fundamental strength and the REITs catering to those asset classes reaped benefits.

Among them are the data center REITs that posted a total return of 18.0% with growth in cloud computing, Internet of Things and big data. Moreover, infrastructure REITs gained 15.7% and Specialty REITs delivered returns of 14.3%, handily outpacing the broader market.

In addition, any rate hike would eventually be backed by economic improvement. And when economic growth gathers steam and inflation rises, prices of real estate generally increase, and rent and occupancy of properties go up.

But not every category of real estate is likely to get an equal boost and not all locations are equally poised to flourish. Therefore, investors need to remain cautiously optimistic and assess the fundamentals of the underlying asset category before making any investment. Further, the capacity of REITs to absorb a rate hike should also be considered. Hence, things like lease durations and pricing power in the market would command attention.

Dividends Standing Tall

Dividends are by far the biggest enticement to invest in REIT stocks, and income-seeking investors continue to prefer them. This is because, as of Apr 28, 2017, the dividend yield of the FTSE NAREIT All REITs Index was 4.14%, which handily outpaced the 2.01% dividend yield offered by the S&P 500.

Among the REIT market components, the FTSE NAREIT All Equity REIT Index enjoyed a dividend yield of 3.85% while the FTSE NAREIT Mortgage REITs Index had a dividend yield of 9.55%. Over long periods, REITs have outperformed the broader indexes with respect to dividend yields.

U.S. law requires REITs to distribute 90% of their annual taxable income in the form of dividends to shareholders. This unique feature made the industry stand out and gain a solid footing over the past 15–20 years.

Capital Access

Further, in recent years, REITs managed their balance sheets well and focused on lowering debt and extending maturities. Also, REITs have indeed been proactive in the capital market, with the stock exchange-listed REITs collecting $69.6 billion in capital offerings in 2016. Moreover, $23.11 billion of capital raised in the first quarter of 2017 was more than in any quarter since the second quarter of 2014. This denotes investors’ growing confidence in the industry. Further, as of Apr 28, 2017, REITs have raised $26.4 billion in capital.
 

Zacks Industry Rank

Within the Zacks Industry classification, REITs are broadly grouped in the Finance sector (one of the 16 Zacks sectors) and further sub-divided into four industries at the expanded (aka "X") level: REIT Equity Trust - Retail, REIT Equity Trust - Residential, REIT Equity Trust - Other and REIT Mortgage Trust. The level of sensitivity and exposure to different stages of the economic cycle vary for each industry.

We rank 256 industries in the 16 Zacks sectors based on the earnings outlook and fundamental strength of the constituent companies in each industry.

We club our industries into two groups: the top half (industries with the best average Zacks Rank) and the bottom half (the industries with the worst average Zacks Rank). Over the last 10 years, using a one-week rebalance, the top half beat the bottom half by a factor of more than 2 to 1. (To learn more visit: About Zacks Industry Rank.)

The Zacks Industry Rank is #162 for REIT Mortgage Trust, #187 for REIT Equity Trust – Other, #191 for REIT Equity Trust – Retail and #208 for REIT Equity Trust – Residential.

Earnings Trends

We are in the final stretch of the current reporting cycle. So far, the finance sector, of which REITs are part, has revealed strength and better-than-expected results. Results from all the S&P 500 financial counterparts were out by May 19. Total earnings increased 10.4% year over year backed by 5.2% higher revenues, with 72.3% beating EPS estimates and 68.1% exceeding top-line estimates. (Read: Not Every Retailer is Suffering This Earnings Season)

For more information on earnings for this sector and others, please read our 'Earnings Trends' report.

However, the performance of the REIT industry has so far been mixed.

Per a NAREIT media release, occupancy rates touched record levels in the first quarter of 2017, while funds from operations (“FFO”), a widely used metric to gauge the performance of REITs, reported a decline from the prior quarter.

In fact, the Q1 scorecard reveals that total FFO of the listed U.S. Equity REIT industry of $14.3 billion in the reported quarter declined 3.9% sequentially. However, the figure came 8.1% higher than the prior-year quarter tally.

Nevertheless, same-store net operating income (NOI) reported 3.7% year-over-year growth. Results were driven by segments like Data Centers, Single Family Homes, and Industrial, which delivered robust same-store NOI growth of 8.0%, 7.3% and 5.9%, respectively.

Furthermore, properties owned by the listed Equity REITs enjoyed solid occupancy levels. In fact, the occupancy rate touched a record high of 93.9% in Q1, indicating an expansion of 30 basis points (bps) from the previous quarter and 84 bps from the year-ago period.

REITs Worth Adding

Over the last three months, the industry has lost around 3.0% compared with the S&P 500’s gain of 1.1%. As the industry underperformed the broader market, the stocks are good bargains now.

Investors can consider the following REIT stocks that have solid fundamentals to weather any rate hike. Also, their favorable Zacks Rank makes them solid picks.

American Tower Corp. (AMT Quick QuoteAMT - Free Report) is a REIT that is engaged in the ownership, operation and development of multitenant communications real estate with a portfolio of over 147,000 communications sites. It has a Zacks Rank #1 (Strong Buy). It is also steady performer having exceeded the Zacks Consensus Estimate in each of the four trailing quarters with an average beat of 4.78%. The stock is trading at a discount to the industry average.

CoreCivic, Inc. , formerly the Corrections Corporation of America, provides correctional, detention and residential reentry facilities. With positive estimate revisions over the past two months and a VGM Score of B, CoreCivic can be a solid addition to one’s portfolio. Notably, VGM is also of great assistance in selecting stocks. Importantly, this scoring system helps in picking winning stocks in their individual industry categories. The stock currently has a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Prologis, Inc. (PLD Quick QuotePLD - Free Report) is an industrial REIT based in San Francisco, CA. Amid a consistent shift toward e-commerce and supply chain strategy transformations, Prologis is well poised to benefit from its capacity to offer modern distribution facilities in strategic infill locations.

Prologis has exceeded estimates in three out of the trailing four quarters with an average beat of 1.90%. This Zacks Rank #2 (Buy) stock is also trading at a discount to the industry average.

PS Business Parks, Inc. is Glendale, CA-based is a REIT, which owns, acquires, develops and operates commercial real estate properties, especially multi-tenant flex, office and industrial. It has a Zacks Rank #2 and delivered positive surprises in all of the trailing four quarters, with an average beat of 3.42%. The stock is also trading at a discount to the industry average. Moreover, PS Business Parks’ estimates for 2017 FFO per share climbed 1.3% to $6.01, over the past seven days.

Note: All EPS numbers presented in this write up represent funds from operations (“FFO”) per share. 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.

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