Investing.com – BCA Research in a recent note called on investors to take a cautious approach to the recent rally in the real estate sector, which has been the best-performing sector in the world, with struggling sectors such as office REITs leading the way.
However, BCA analysts warn that this momentum may not be sustainable.
While the real estate sector's dividend yield looks attractive amid falling interest rates, BCA says there are several challenges that could impact the sector.
“REITs will struggle if economic growth falters despite rate cuts,” the note explains.
BCA explains that REITs historically tend to outperform just before the first rate cut, but consolidate gains shortly afterward, a pattern investors should consider.
Crucially, BCA says the outlook for the real estate sector is mixed. Although balance sheets remain healthy, the firm notes that “net operating income is slowing” and margins have only returned to pre-pandemic levels.
Additionally, pandemic-related disruptions are said to have created pockets of distress within the sector, which are now widening.
BCA recommends investors underweight certain subsectors, including industrial REITs, which face pressure from a manufacturing slowdown and slower online retail sales, as well as residential REITs, dominated by multifamily units struggling with overconstruction, the sluggish growth in rents and the increase in delinquencies.
BCA adds that the office REIT subsector also faces headwinds due to high vacancy rates and rising distressed loans.
The research firm suggests an overweight position in specialty REITs, which offer exposure to the digital economy.
“Underweight the real estate sector in a tactical investment horizon,” says BCA. recommends maintaining an underweight stance on real estate in the short term, expecting economic growth to slow. We expect economic growth to slow, and even lower interest rates will not benefit the sector in such conditions. Furthermore, default rates are rising and widening across all sub-sectors, which does not bode well for the performance of the sector.”
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