Since October 2022, the broader stock market has experienced a nice recovery coming out of the bear market.

However, real estate investment trusts (REITs) have not participated fully in the stock market gains of the last ten months. As a result, REITs look very undervalued and may be the next sector to move strongly higher.

Let’s take a look to see if that’s likely…

To look at where REIT values have gone, I used Nariet Index monthly data for equity REITs, which own commercial properties. Most REITs focus on a single type of commercial property, such as self-storage, offices, or shopping centers. Nariet lists a dozen equity REIT sectors.

The equity REIT index peaked at the end of 2021, along with the broader stock market. By the end of October 2022, the index had fallen by 25.5%. Over the same period, the S&P 500 declined by a similar 27% to its October low.

From that month’s market bottom through the end of July 2023, the S&P 500 index increased by 31%. The Nariet Equity REIT index was up 5.8%.

There are a couple of reasons for the lagging results from the REIT sector. REITs are viewed as more interest rate-sensitive, and as the Federal Reserve has kept hiking rates, investors have stayed clear of the sector. Also, a few types of REITs—primarily those that own office buildings and self-storage facilities—have continued to perform negatively. The financial media has well reported the challenges owners of major city office buildings face, and most investors don’t differentiate between types of REITs.

Now, other factors should let REITs return to positive price action. First, the Fed is at or near the end of its interest rate hikes. Market experts expect the fed funds rate to start slowly lowering starting sometime next year. Remember that the market tends to anticipate good news, so REITs could start to rally long before significant rate cuts are a reality.

The second quarter earnings reports, which came out over the last month, showed that most REITs are in good financial shape. The higher-quality firms are actively searching for situations in which they can use their superior balance sheets to pick up assets from distressed owners. REITs are in good financial shape, and many will continue to grow their dividends. On that front, average yield for the Nariet Equity REIT Index sits at 4.0%, compared to 2.59% at the end of 2021. Investors getting in now will earn a nice yield while waiting for the recovery.

The Hoya Capital High Dividend Yield ETF (RIET) is my recommended fund for REIT exposure. The fund uses a unique strategy to own 100 REITs balanced across five categories. Here is the breakdown:

RIET strives to pay a higher yield, which currently is at 9.65%. The fund pays stable monthly dividends.