By Paul R. La Monica

The good old days for traditional real estate companies may be over -- but real estate investment trusts may just be getting ready to rally.

It's been dark times for real estate in recent months. Rising mortgage rates have wreaked havoc on the residential market, while commercial real estate remains a quagmire as more people work from home -- despite the best efforts of JPMorgan Chase, Tesla, Amazon.com, and others to mandate a full-time return to the office. The Real Estate Select Sector SPDR exchange-traded fund (ticker: XLRE) returned just 5.1% in 2024, even as the SPDR S&P 500 ETF $(SPY)$ gained 25%.

But the sector may have finally bottomed. Valuations seem reasonable, and if long-term bond yields continue to slide as inflation worries subside, real estate stocks may regain their appeal as bond proxies thanks to their generous dividends. The yield for the Real Estate SPDR ETF is 3.4%.

But REITs aren't just for dividend investors. Some may also benefit from the animal spirits that have boosted the overall stock market since Donald Trump's election in November. The Real Estate SPDR ETF has warehouse giant Prologis, wireless infrastructure company American Tower, and data center leaders Digital Realty and Equinix as top holdings.

Prologis President Dan Letter said during the company's fourth-quarter earnings conference call this month that there has been a "boom" in demand since November, with "previously stalled deals" now being signed. He added that Prologis was seeing broad-based resilience from a variety of customers, including e-commerce, general goods, and food and beverage companies. The stock has gained 7.4% this week through Thursday.

Other logistics and infrastructure REITs also stand out. Morningstar analysts recently identified American Tower competitor Crown Castle, which has a dividend yield of 7%, as well as Americold, a leader in cold storage warehouses for perishables, pharmaceuticals, and chemicals, which yields more than 4%, as top picks for this year. The analysts noted that Crown Castle should benefit from more spending by big carriers like Verizon and AT&T. "Consumers' mobile data consumption is rapidly expanding," they noted, adding that "towers will continue to provide the needed infrastructure and be a necessary part of the larger mobile communications network." And Morningstar argues that Americold stands to gain "as food manufacturers continue to ramp up production and supply-chain issues and labor shortages abate."

But residential real estate is enticing despite rising mortgage rates. Fund managers at Pimco said in a report in December that they like single-family rental properties as well as student housing, due in large part to housing shortages throughout the U.S. Morningstar likes Sun Communities, which is a big owner of second homes and vacation properties in Florida and Michigan, two markets that are attracting more retirees. Morningstar says Sun "has benefited from an aging population with a desire to own a second home or have the time to go on regular vacations." The stock yields 3%.

Investors should tread cautiously in other parts of the sector, particularly office REITs. While the commercial real estate market could rebound a bit, it may never return to where it was before the pandemic. The Morningstar analysts suggested that if investors do want to bet on offices, they should look at companies catering to the life-sciences sector because biotech companies looking to develop new drugs will need space, and there is growing demand for medical offices as well. Kilroy Realty and Healthpeak Properties, which both yield nearly 6%, could benefit.

Just continue to keep an eye on Treasury yields. REITs may continue to lag the broader market if inflation jitters resurface and investors start to worry about the Federal Reserve having to go on an extended rate pause. "Investors in REITs should closely monitor the bond market and be prepared for potential volatility in the REIT sector," said Kevin Flanagan, head of fixed-income strategy at WisdomTree in a recent report.

The good news, though, is that these worries may already be priced into the stocks. REITs are trading at about 18 times earnings estimates for 2025, below their five-year average. They also trade at a discount to the S&P 500's 22 times, when they've historically traded at a market multiple.

And oh yeah, the juicy dividend yields don't hurt either.

Write to Paul R. La Monica at paul.lamonica@barrons.com

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January 24, 2025 01:00 ET (06:00 GMT)

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