Wells Fargo: Downgrading REITs to Unfavorable amid interest rate rises

U.S. one-dollar currency notes; taken September 2018.U.S. one-dollar currency notes; taken September 2018.

Wells Fargo Investment Institute downgraded REITs to Unfavorable from Neutral, saying real-estate fundamentals have weakened so much that real estate no longer looks as attractive as other investments.

“In June, we downgraded global REITs from favorable to neutral, citing the twin headwinds of an aging economic cycle and rising long-term interest rates,” it said in a note on Thursday.

“The sharp increase in U.S. interest rates in early October has heightened our concerns, and our unfavorable rating reflects our view that the potential downside risks are greater than the upside reward potential,” it added.

Wells Fargo Investment Institute said the interest rate sensitivity of REITs appears to have increased in recent years. In addition, the REITs are trading at only slight discounts to their net asset value, or the value of their underlying real estate, it said, noting commercial real-estate price increases are starting to slow.

“Historically, larger discounts have been needed for investors to commit capital to this asset class,” it said. “Looking forward, REIT fundamentals appear less-than-inspiring as the aging recovery is expected to negatively impact same store net operating income and occupancy rates.”

Wells Fargo advised re-allocating from REITs to U.S. large-cap stocks, pointing to supportive conditions from earnings growth.

“Valuations also look compelling, especially the valuation levels that have been reached since the market pullback that began on September 22,” it said.

It estimated that the S&P 500 was trading at a price-to-earnings multiple of 16.8 times, based on the index level on 16 October and its estimate of US$166 earnings per share for the index through September 2019.

That was around its 20-year average of 16.7 times, and below the 17.6 times it was trading at on 21 September, Wells Fargo said.

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