[VIDEO] 3 Things you Need to Know about REITs
REITs are breaking out and things are looking brighter, but what are the risks?
[VIDEO] 3 Things you Need to Know about REITs
In this video we walkthrough the 3 key things you need to know about the latest price developments in REITs, the macro/sentiment drivers behind it, and the remaining risks around leverage, rates, and valuations. n.b. the transcript is available below.
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VIDEO TRANSCRIPT
For accessibility and convenience, here’s the transcript from the video above:
Something interesting is going on with REITs, and there's 3 things you need to know for this much-hated asset class [namely, the turn in technicals, the drivers of the turnaround, and remaining risks]
1. the technicals are turning
-we've seen bullish divergence (higher low on the RSI vs lower low on price), which is a great predictor of turning points
-also seen an inverted H&S (initial low, followed by a lower low, then a higher low + breakout), again, also a good indicator of turning points, particularly at the end of a drawnout trend like this
-and REITs have recaptured their 50-day moving average
So technically, it looks good, but what's driving this?
2. here's why REITs are rallying
-breadth was oversold, positioning or allocations to REITs were basically at record lows, and sentiment was extremely bearish (which I always say, represents a lot of minds that can be changed)
-we had also seen a significant reset in REIT valuations, more-so than commercial or residential, and typically this is what we usually see: REITs are the fastest to see a valuation adjustment (and also first to turn, being more liquid, or hyperactive as you might say)
-lastly, a big driver of drawdowns for REITs has been the surge in bond yields, which has squeezed the dividend yield spread -- making REITs less attractive for income oriented investors
--so in that backdrop it was just awaiting a catalyst, which has been delivered in the form of an increasing belief that the Fed is done, and bond yields are headed lower (and the US 10-year has already fallen 50bps in recent weeks)
3. but what are the remaining risks?
-aside from the technicals, and REITs still need to overcome long-term resistance + their 200-day moving average, there are 3 things to consider
-first: debt levels are still relatively high (almost twice the leverage of the 1980's), and effective borrowing costs are turning higher for REITs
-second: while valuations have reset significantly, absolute valuations for REITs still remain elevated vs longer-term history
-third: the underlying (commercial and resi) are still trading at eye-watering levels, and are at risk of a more meaningful downside adjustment if bond yields head higher again (higher-for-longer risk), and/or if the economy rolls over into recession
--so definitely a good setup for a trading rally, which we have seen already, and certainly some promise for REITs, but clearly not without fundamental risks
So to sum up, REITs have turned the corner for now -- this comes from a classic contrarian setup of extreme pessimism and valuation reset, but there are still notable risks to keep on top of in this space even as things start to look brighter.
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