Fed Talks Three Cuts, REITs Go Ballistic — What To Do Now?

It's often said that staying in the market beats trying to time the market and when Wall Street has a day like Wednesday when the Federal Reserve said it may cut interest rates three times in 2024, it proves that point.

Real estate investment trust (REIT) investors were especially celebrating Wednesday after the Federal Open Market Committee (FOMC) meeting announcement because REITs, which had been bouncing back since late October, exploded with huge share price gains.

One question is whether REITs have become short-term overbought, and if so, should investors add to positions now or wait for a pullback? Another question: Should investors buy the REITs that have recently performed the best or favor the ones whose rally has not left them so overextended? The simple answer is to look for those stocks with the greatest relative strength.

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Relative strength is an important concept when comparing stocks because it defines how the performance of a particular stock or sector compares to other similar stocks or other sectors. Stocks that appreciate more than others in up markets and pull back less than others during down days are said to have stronger relative strength. Those are the best stocks to buy until and unless the relative strength story changes.

Wednesday's huge rally in REITs showed that the greatest relative strength in the sector is in the office REITs. On Wednesday, eight of the 10 largest gains among all REITs priced $4 or more were office REITs. The five best-performing issues and their gains on Wednesday were:

Hudson Pacific Properties Inc. HPP 11.74%

JBG Smith Properties JBGS       11.65%

SL Green Realty Corp. SLG         10.93%

Vornado Realty Trust VNO          10.77%

Boston Properties Inc. BXP           8.51%

One of the reasons that office REITs have performed so well recently, and especially after the latest Fed announcement, is because they're so far from the highs set before the beginning of 2022. Also, REITs need lower interest rates to borrow money for purchasing properties that will spin off higher capitalization rates or to refinance maturing debt in 2024 at lower rates than have been available over the past two years.

Lower inflation also reduces costs for those who drive to work and that has some influence over workers' motivation to return to offices rather than working from home. That could help stabilize office occupancy rates.

The only two non-office REITs that finished in the top 10 performers Wednesday were Hannon Armstrong Sustainable Infrastructure Capital Inc. HASI, a mortgage REIT (mREIT) that loans money for green energy projects, and retail-REIT, Macerich Co. MAC. Both REITs have been solid performers over the past four weeks, with Hannon Armstrong up 14.4% and Macerich up 18.53%.

One office REIT that had a small gain on Wednesday but was nowhere near the rest of the office sector was Equity Commonwealth EQC. It rose 0.83% and has gained 1.84% during the big REIT rally over the past four weeks. That's the perfect example of a stock with poor relative strength and shows why it's always best to buy the stocks with the strongest relative strength rather than the laggards.

By contrast, Hudson Pacific Properties, which was the best-performing REIT on Wednesday has also been a solid performer over the past four weeks, with a gain of 27.69%. Hudson Pacific, which has a small portion of its portfolio in Hollywood Studios, was hurt badly in 2022 by the Hollywood actors and screenwriters' strike. Once those strikes were settled, Hudson Pacific began to rally again.

Hudson Pacific closed yesterday at $8.09, and it's more than doubled since touching a low of $4.38 on Nov. 1. Hudson Pacific traded near $25 per share in March 2022 before the first of several Federal Reserve rate hikes, so it's still far from its previous highs. Most of the other office REITs are also well below the highs attained before 2022.

What should investors do now? If you have a long-term horizon, these office REITs can be purchased now, even if they've been somewhat overextended over the past six weeks. The dividend yields of all the REITs shown above, except for Macerich, are still between 5% and 11.5%.

More conservative investors may want to wait for a pullback before entering positions, but it's also possible that these REITs can move much higher before pulling back. Technical indicators like the 14-period relative strength index (RSI) and Stochastics Oscillator signal that these REITs are in overbought territory, but that doesn't mean they're finished with their ascension. Overbought simply means that the risk/reward ratio is beginning to move more toward the risk side, but stocks can remain overbought for quite a while and still move higher.

Money market accounts are still paying around 5%, so waiting and missing out on a few percentage points of appreciation might not be the worst thing. Another possibility is for investors to dollar cost average into their favorite REITs over the next month or two.

Fear of missing out (FOMO) is very real now, and many investors and institutions that have been avoiding REITs for a long time will be jumping back on the train. It takes a long time for institutional money to completely fund its positions, so it seems that REITs could perform far better over the next year than they have since 2021.

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