Investing.com – BCA Research asked investors in a recent note to take a cautious approach to the recent rally in real estate, which has been the best-performing sector in the US, with distressed sectors such as Office REITs leading the way.
However, BCA analysts warn that this momentum may not be sustainable.
While property dividend yields look attractive amid low interest rates, BCA says there are several challenges that could impact the sector.
“Real estate investment trusts will face difficulties if economic growth falters despite interest rate cuts,” the note explains.
BCA explains that historically, REITs tend to outperform just before the first interest rate cut but consolidate gains soon after, which is a pattern investors should consider.
Essentially, the BCA says the outlook for real estate is mixed. Although balance sheets remain healthy, the company notes that “net operating income is slowing” and margins are only returning to pre-pandemic levels.
In addition, the pandemic-related disruptions are said to have created pockets of distress within the sector, which are now widening.
BCA recommends investors reduce the weight of certain subsectors, including industrial REITs, which are facing pressure from declining manufacturing and slowing online retail sales, as well as residential REITs, which are dominated by multifamily units that are grappling with overbuilding, slow Rent growth and high late payment rates.
BCA adds that the office REIT sub-sector is also facing headwinds from high vacancy rates and an increase in non-performing loans.
The research firm suggests an overweight in specialty REITs, which provide exposure to the digital economy.
“Underweight properties are on the tactical investment horizon,” BCA says. He advises maintaining a low-weight position on real estate in the near term, anticipating that economic growth will slow. We expect economic growth to decline, and even lower interest rates will not benefit the sector in such circumstances. Moreover, delinquency rates are rising and expanding across sub-sectors, which does not bode well for the sector’s performance.