Investing.com – BCA Research in a recent note urged investors to be cautious about the recent rally in the real estate sector, which is seeing the best performance in the industry, led by distressed sectors like Office REIT.
However, BCA analysts warn that this dynamics may not be sustainable.
While real estate dividend yields appear attractive in the face of falling interest rates, BCA points to several challenges that could impact the sector.
“REITs will struggle if economic growth declines despite interest rate cuts,” the note explains.
BCA explains that historically, REITs have tended to outperform just before the first interest rate cut, but consolidated gains shortly thereafter, which is something investors should take into account.
Essentially, BCA says the outlook for real estate is mixed. While balance sheets remain robust, the company notes that “net operating income is declining” and margins have only returned to pre-pandemic levels.
Additionally, pandemic-related disruptions are said to have created unrest in the sector, which is now increasing.
BCA advises investors to underweight certain subsectors, including industrial REITs, which are facing pressure from the manufacturing downturn and slower online retail sales, and residential REITs, dominated by multifamily units struggling with overbuilding, snail-paced rent growth and growing arrears.
BCA adds that the Office REIT subsector is also struggling due to elevated vacancy rates and rising non-performing loans.
The research firm suggests an overweight position in specialized REITs that offer exposure to the digital economy.
“Undervaluing real estate over a tactical investment horizon,” says BCA. He advises to maintain an underweight approach to the real estate market in the near term, expecting a slowdown in economic growth. We expect economic growth to snail-paced and even lower interest rates will not benefit the sector in such conditions. “Furthermore, crime rates are rising and spreading across sub-sectors, which does not bode well for the sector’s performance.”
