By Ian Salisbury

Investors might finally have a buying opportunity in front of them for the long-struggling real estate sector.

For weeks, stubbornly persistent inflation has caused investors to fret. Some of those fears were allayed Wednesday when the latest reading for the core consumer price index -- which excludes volatile food and energy prices -- came in softer than expected. That's good news for sectors that thrive in lower-rate environments, like real estate investment trusts.

Yields on 10-year Treasury notes, which rallied in recent weeks, tumbled 0.14 percentage points to 4.65% on Wednesday. Meanwhile, the stock market rallied with big gains for interest-rate sensitive corners of the market like real estate investment trusts, or REITs. The Schwab U.S. REIT ETF was up about 1% in early trading.

Lower rates make it easier for real estate firms to finance purchases -- while also pushing up real estate values, since prospective buyers can borrow more, enabling higher bids on properties.

REITs have had a tough year as expectations for steep rate cuts by the Federal Reserve failed to materialize, and the commercial property sector continues to struggle amid the work-from-home revolution. Over the past 12 months, real estate stocks have returned just 1.2%, badly lagging behind the S&P 500's 22% return.

By the same token, however, the sector has gotten cheap. The Schwab ETF trades at just 15 times 2025 funds from operations (REIT's equivalent to a price-to-earnings ratio) compared with the S&P 500's forward PE of 21. REITs' average yield -- 3.2% -- also compares favorably to the S&P 500's 1.2%.

That has led to cautious optimism.

"From a supply-demand perspective, real estate fundamentals appear to be bottoming out," wrote Fidelity portfolio managers Steve Buller and Sam Wald in a recent report.

What's more, some slices of the REIT market, such as data center and healthcare REITs, have attractive growth prospects, they note. Data centers stand to benefit from demand for artificial intelligence, while healthcare REITs could capitalize on the millions of baby boomers entering their golden years.

Of course, investors face a trade-off. REITs in booming growth areas tend to have higher valuations and lower yields. Still Buller's fund, Fidelity Real Estate Investment Portfolio, owns stocks like self-storage company $Public Storage(PSA-N)$, which yields 4.1%, and commercial real-estate-focused NNN REIT, which yields 5.8%.

Guy Barnard, co-manager of the Janus Henderson Global Real Estate fund is also bullish. He argues the prospect of higher rates and other headwinds have already been baked into real estate prices, paving the way for 2025 growth.

"Share valuations have rarely ever been more discounted relative to broader equities," he wrote recently.

Barnard singles out senior housing REIT Welltower, with a 2% yield, as one of his top U.S. picks for 2025.

The company "successfully leveraged its best-in-class operational platform with more than $6 billion of accretive acquisitions...in a sector facing demographic tailwinds and limited new supply in the years ahead," he wrote.

Also in his portfolio are several yield plays: Realty Income, a commercial REIT that yields 5.9%, and Sabra Health Care REIT, with a 7.1% payout.

Write to Ian Salisbury at ian.salisbury@barrons.com

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January 15, 2025 13:19 ET (18:19 GMT)

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