This one Niche of the Sagging Real Estate Market is Growing Rapidly

Simon Property Group (SPG) is the largest retailer-backed real estate investment trust (REIT) in the US and traded a 3.3% gain at market close on June 5, 2019. Commercial real estate companies grew in terms of market cap of more than 15% since February 1, and 23.6% over the past three months. By the end of the year, we think all REITs will increase market caps above their historical five-year average because the average retail rents are falling substantially.

So what is driving the rise in market cap of commercial real estate companies, according to analysts at BMO Capital Markets? Strong corporate earnings, and demographics, to name a few.

The commercial real estate investment cycle is also still in the late stages of the bull market. While traditional high-growth regions like the US are running out of steam, some of the world’s largest markets are still in vogue because of the strength of the economy.

Commodity-driven Southern Africa, Mexico, and the Middle East led the increase, as markets that have been benefiting from over-supply for the most part have started to see their supply decline. China’s demand for materials is also keeping demand for raw materials such as iron ore, zinc, and nickel up.

However, the thing that is the biggest gainer for the market cap of commercial real estate companies is the niche markets of the retail sector, especially malls.

Below are a few demographic factors that are influencing consumer spending that will continue to support the growth of the retail sector:

1. Declining inflation

Retail stores sell products that are broadly priced and haven’t seen significant price increases in the past. A lack of inflation is expected to continue because of the significant amount of inflation over the past 15 years. That was great for companies like REITs during that time period, but low inflation means that consumers now have greater bargaining power. And consumers don’t like to buy more than they need.

From a policy perspective, there’s more upside for individuals and consumers to keep inflation low because the Fed is raising interest rates, making it more expensive for consumers to own assets.

2. Consumers are saving more

Americans are likely to drive consumer spending if they have more spare cash. The average person currently holds around $1,600 of cash in their bank account. That amount is up from $350 in 2009 when the recession ended.

That means Americans are saving more and is likely to be reflected in consumers’ buying habits. The belief that any and all savings is wasted translates into consumers saving.

On the other hand, financial markets are losing value and the value of property and businesses is driving both consumption and investment.

3. Consumer services consumption grows

Consumers are expected to spend more on things like dining out, entertainment, travel, car servicing, and schooling. The idea is that if consumers are spending more on things like services, it means that companies like REITs will be doing better. If consumers are spending more on services, then that means a company is getting more sales from a household and that is something a REIT like Simon Property Group and Retail Opportunity Investments Corporation (ROIC) stands to benefit from.

4. Millennials also expect things that traditional retail stores offer

Millennials want to buy experiences, not just products. And while traditional retailers have benefited from a trend of online purchasing, the influence of the millennial generation is still relatively new and strong. Millennials are the most affluent and most tech-savvy generation in history.

This in addition to the large number of millennials that are expected to move into the middle class in the next several years means that millennials are going to have more spending power.

According to Insight Economics, we think all REITs will benefit from this new market demand, but the retail REIT market will likely continue to rise, and we think mall REITs will be the most promising.

REITs have achieved relatively strong returns in the last few years and despite the negative perception of many retail REITs, we think that they are still great values right now.

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