Real Estate Stocks Are Crushing the Market as Cloud Fuels Growth

Investors' rush to defensive positions in an uncertain market has pushed real estate stocks higher, with some gaining more than 50% this year, roughly triple the pace of the S&P 500. Now, these stocks are likely to rise even higher as trade conflicts and other headwinds rattle the market. Those set to benefit the most include American Tower Corp. (AMT), Equity Residential (EQR), Equinix Inc. (EQIX), Essex Property Trust Inc. (ESS), Crown Castle International Corp. (CCI), Public Storage (PSA) and Prologis Inc. (PLD), as outlined in a recent Barron’s report. 

Safer Bets Outperform

Heightened demand for shares of companies in safer industries, with less exposure to overseas markets, has driven up prices for real-estate investment trusts or shares of companies that own office towers, hotels, shopping malls, and other commercial properties.

Steve Shigekawa, manager of the Neuberger Berman Real Estate fund, focuses on stocks of high-quality companies with “low debt, diverse property portfolios, and experienced management teams that have run their companies through multiple economic cycles,” per Barron’s. This investment strategy has led the Neuberger Berman Real Estate fund to post a 12.0% annualized return over the past three years, outperforming 90% of its peers in Morningstar’s real estate category. In the past decade, its older institutional share class has beaten 79% of its peers. 

Instead of investing in traditional real estate companies, such as lodging, shopping centers, and regional malls, in which Shigekawa’s fund has a less than 7% exposure, he has doubled down on data-center companies, in which the fund has a 12% exposure. 

“We have lower exposure to the more-cyclical property sectors like lodging and retail, given the impact of e-commerce on retail sales,” said the fund manager. Shigekawa’s fund uses a top-down approach to stock picking, looking at macroeconomic indicators to help guide investments in about 40 companies. For example, a period of lower interest rates has helped boost shares of real estate stocks, which often suffer during periods of rising interest rates because of the amount of debt they take on. 

Data Center Companies 

One force driving these companies' growth is soaring demand for data centers to support cloud computing. “When you think about the demand for cloud computing, that’s going to require more data centers,” said the fund manager. This trend will particularly boost data center real estate companies like Redwood City, Calif.,-based Equinix, whose shares have skyrocketed more than 62% year-to-date (YTD). 

The leading firm in the data center space lists properties in 24 countries around the globe, and says it has been largely unaffected by a re-escalation of trade tensions from Washington. 

 “While the global trade of physical goods is flattening, the opposite is true in terms of our global digital economy,” said Equinix CEO Charles Meyers. 

Meanwhile, both data centers and tower REITs should benefit from the switch to the next generation of cellular networks, called 5G, which is expected to be 10 times faster than the current 4G phones. Cellphone tower REITs, also known as “infrastructure REITs” made up 17% of the Neuberger Berman Real Estate fund. 

REITs as Stable ‘Risk Mitigators’

Scott Craig, portfolio manager of Eaton Vance Real Estate fund, views REITs as an effective way to hedge against market volatility, per another Barron’s report. As headwinds persist, REITs could continue to rally as they gain popularity as a “risk mitigator” with steady income and locked in cash flows. 

While REITs with operations overseas and revenues in multiple currencies may be more exposed to foreign exchange volatility, they are typically larger in scale and maintain strong growth profiles and balance sheets, per the Wall Street Journal

What’s Next? 

Moving forward, investors will likely favor companies that cater to the global digital economy, rather than cyclical names that are more vulnerable to economic downturns, tariffs, and industry-specific disruption like retailers and hotels.

Other segments of the market that could experience turbulence include those that may face higher costs like construction, as well as weaker consumer sentiment, and labor shortages, per Sandler O’Neill + Partners LP, cited by the Journal.

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