The great REIT reset has begun

Kevin Warsh loves the markets.

He loves them not.

Kevin Warsh loves the markets.

He loves them not.

Like a little girl picking the petals off a daisy, the markets have been going back and forth about what the Federal Reserve will do under its new chairman.

Everyone knows he’s supposed to be President Trump’s man when it comes to rate cuts. But the economic data out since he was sworn in on May 22 has been volatile.

One report shows strength; the next pressure. So experts are absolutely certain one moment that the Fed will raise rates. The next, they’re considering the possibility of cuts later on this year.

Warsh himself has stayed pretty tight-lipped throughout this other than to say that he wants incoming economic data to dictate decisions, not predetermined policy. So he’s been reiterating Fed goals about taming inflation… without giving any actual idea about how that will be accomplished.

This has frustrated many investors. But it’s perhaps been most annoying for businesses like real estate investment trusts, or REITs. Because they’re so heavily dependent on borrowing to fund their operations, the markets tend to punish them whenever lenders start charging more.

When interest rates go up, REIT shares go down. When rates fall, REITs rise. There’s little individual portfolio evaluation involved.

Fortunately, I believe we’re finally moving away from that mentality – even as the Federal Reserve meets this week and we all wait for its official decision on Wednesday. Instead of obsessing over what decision will be announced, the markets are looking at what REITs themselves are reporting.

Which means they finally recognize that these companies are performing just fine even in this nonideal market environment.

I’m not trying to say this week's Federal Reserve meeting doesn’t matter at all for REITs. Or that I’m not interested to see what happens.

It is, after all, shaping up to be one of the least predictable central bank decisions in years.

Only a few months ago, there was almost no talk whatsoever about rate hikes. Since peace had largely returned to the Middle East, oil prices were falling and inflation appeared to be cooling.

But since we’re back at war, speculators now give a roughly one-third chance for a one-quarter-point hike. So I guess we’ll soon see if that decently sized prediction comes true.

If it does, REIT prices might fall for a day or two. But here’s an encouraging development I’ve noticed this year: Investors are beginning to focus more on their fundamentals instead of macro-economic factors.

Equity REITs have returned about 14.6% year-to-date – a clear step up from the S&P 500’s 9.4% gain. And since nothing has changed in terms of all the back-and-forth guesses about the Fed… elevated Treasury yields… and geopolitical uncertainty…

I have to conclude that, after three years of ignoring the obvious, investors are finally rediscovering that REIT shareholder returns are driven by:

Not interest rates.

Interest rates can make managements’ job more complicated in operating all of that, of course. But the kind of executive teams we seek out here at Wide Moat Research are more than capable of handling the challenge.

They’ve proven that for years on end. And they’re finally being recognized for those well-done jobs.

In the same way, we’ve seen a few REITs go public this year as favorability grows. Merger and acquisition (M&A) activity is rising. Private equity firms are once again stepping into the commercial real estate space. And public-private transactions are increasing as well.

In short, capital is beginning to flow back into high-quality real estate. So REIT share prices are rising as a result of that re-focusing on fundamentals.

Speaking of fundamentals, I know we're still in the early innings of REIT earnings season. There are still nearly 200 scheduled to report over the coming weeks, and anything can happen from here.

All the same, what we’ve seen so far has been exceptionally encouraging.

Take Digital Realty (DLR), which just reported one of the strongest quarterly data-center results I've seen in quite some time.

Core funds from operations (FFO) rose $2.13 per share, up 14% year over year – and well above Wall Street expectations. Cash renewal spreads hit a record 25.4%. And leases, which exceeded one megawatt (MW), produced absolutely impressive renewal spreads of 66.7%.

You don’t get a much clearer picture of extraordinary demand colliding with constrained supply.

As a result, management raised full-year guidance for the second consecutive quarter and expressed confidence that double-digit FFO growth can continue through 2027. And beyond.

Shares surged on the news, rising around 15%.

Incidentally, I’ve been arguing that all the growing opposition to new data center development will benefit the sector. And Digital Realty's results seem to suggest I’m right.

Industrial REITs are also looking good if Rexford Industrial Realty (REXR) is any indication. That landlord, which owns infill industrial properties throughout Southern California, exceeded expectations, raised guidance…

And announced one of the sector’s largest capital recycling initiatives ever.

Rexford plans to dispose of $1.5 billion to $2 billion worth of assets while simultaneously expanding its share repurchase program – which, for the record, is already aggressive. Management has repurchased about $300 million of stock so far this year, and now it’s authorized another $1 billion.

That's a powerful vote of confidence.

I've long believed Rexford's irreplaceable Southern California portfolio makes it one of the most attractive takeover candidates in the REIT universe. In fact, I explored the company for that very reason on July 1st, though not at length.

I plan to go into much greater detail later this week considering what it just reported.

Elsewhere in the sector, EastGroup Properties (EGP) and First Industrial Realty Trust (FR) both raised their full-year guidance as well. And while they both traded modestly lower following earnings, I believe investors focused too heavily on temporary occupancy concerns while overlooking improving cash flow fundamentals.

The Wide Moat Show’s July 16th episode focused on “7 strong buys” – complete with two stocks trading at especially attractive price points. And we were pretty pleased with those finds.

If you were too, you’re going to love the “7 more bargain stocks” we reveal in this latest video. We’re talking about massive discounts!

Click here to watch Nick Ward and me discuss what these companies are… why they’re trading so cheaply…

And what kind of returns we think they can make for intrepid investors in the months ahead.