What is the real estate sector?
It includes equity real estate investment trusts (REITs) and companies engaged in real estate development and operation.
Over recent years, the Real Estate sector’s domestic orientation and relatively high payout yields have made it attractive, particularly in an environment of low and falling interest rates. Low interest rates enable real estate investors to leverage property with relatively “cheap” money.
However, during periods of financial stress, as we’ve experienced with the COVID-19 pandemic, real estate investment trusts (REITs) tend to struggle. Funding dried up for real estate, and commercial property demand is falling as much of the economy has yet to fully recover—which increases the risk of lease defaults. While net debt for the sector is low by historic standards, the risk to cash flow puts many REITs in a difficult position.
Retail space is under significant stress, as many companies cannot pay rent and may become insolvent. Health care facilities are under stress, with revenues lower amid delayed elective care and expected higher costs for extended and senior care facilities. Shared office space demand is sharply lower, and multi-family lease defaults are expected as unemployment remains very high.
The outlook for the sector will be highly dependent on the speed at which the economy recovers. While government support payments to businesses and newly unemployed workers will help, a slow, drawn-out recovery would become a longer-term headwind for the sector. However, if the economy recovers more quickly, people get back to work and interest rates stay low as the Federal Reserve maintains accommodative monetary policy, the Real Estate sector stands to benefit. In a low-interest-rate environment combined with renewed economic growth, investors’ search for yield could be a strong tailwind for the sector.
Given the high level of uncertainty regarding the path of the real estate market, however, we are maintaining a marketperform rating on the sector.
Sector Overview: Real Estate
Note: Each of the sector lenses shown above—Macroeconomic, Value, Fundamental and Relative Strength—is both intuitive and evidenced-based in nature. Within each, there are a varying number of factors. The Macroeconomic lens includes sector sensitivities to interest rates, stocks and the value of the U.S. dollar; the outlook for each of these is determined by the Schwab Center for Financial Research (SCFR)’s Asset Allocation Working Group, which uses a mosaic approach of quantitative and qualitative considerations. Value includes six different valuation metrics that provide a holistic perspective on current valuations relative to each of the sectors’ own historical valuations, as well as relative to the other sectors. Fundamental provides insight as to how efficiently the companies within each sector use invested capital to produce earnings; this historically has been informative as to future relative performance of the sectors. Finally, Relative Strength measures momentum of the individual sectors against all of the other sectors. We also consider the data in the context of factors outside the scope of these indicators—for example, geopolitical risk or central bank policy changes.
Source: Charles Schwab, as of 10/15/2020
What do the ratings mean?
The sectors we analyze are from the widely recognized Global Industry Classification Standard (GICS®) groupings. After a review of risks and opportunities, we give each stock sector one of the following ratings:
- Outperform: likely to perform better than the broader stock market*
- Underperform: likely to perform worse than the broader stock market
- Marketperform: likely to track the broader stock market
Want to learn more about a specific sector? Click on a link below for more information or visit Schwab Sector Views to see how they compare. Clients can log in to see our top-rated stocks in the Real Estate sector.
* As represented by the S&P 500 index
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