Investing.com -- BCA Research told investors in a recent note to take a cautious approach toward the recent rally in the real estate sector, which has been the best-performing sector in the S&P 500, with distressed sectors like Office REITs leading the charge.
However, BCA analysts warn that this momentum may not be sustainable.
While real estate’s dividend yield appears attractive amid falling interest rates, BCA says several challenges that could impact the sector.
"REITs will struggle if economic growth falters despite rate cuts," the note explains.
BCA explains that historically, REITs tend to outperform just before the first rate cut but consolidate gains shortly afterward, a pattern that investors should consider.
Fundamentally, BCA says the outlook for real estate is mixed. Although balance sheets remain healthy, the firm points out that “net operating income is decelerating” 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 broadening.
BCA recommends investors underweight certain subsectors, including Industrial REITs, which are facing pressures from a manufacturing downturn and slower online retail sales, as well as Residential REITs, dominated by multifamily units grappling with overbuilding, slow rent growth, and rising delinquencies.
BCA adds that the Office REITs subsector also faces headwinds due to elevated vacancy rates and increasing distressed loans.
The research firm suggests an overweight position in Specialized REITs, which offer exposure to the digital economy.
“Underweight Real Estate over a tactical investment horizon,” says BCA. advises maintaining an underweight stance on real estate in the near term, expecting economic growth to slow. We expect economic growth to downshift, and even lower interest rates won’t benefit the sector in such conditions. Further, delinquency rates are rising and broadening across subsectors, which does not bode well for sector performance.”