Since the recovery started to gain traction, real estate investment trusts have been in the middle of what can only be described as a perfect storm.
This year, REIT market capitalization eclipsed $1 trillion.
If that wasn't enough, their "current yield is 3.6%, higher than the 1.7% yield offered by a 10-year Treasury bond," according to The Economist.
It is worth noting that this year may not be an outlier for the REIT sector but rather more indicative of a long-term trend. REITs have outpaced the market since 2014, and this year doesn't look like an exception.
At this pace, REITs have closed the gap between one of the largest sectors in the S&P 500: utilities. For more than two years and counting, REITs have been a stable sector in which to invest, even during times of uncertainty.
Over that time, "they have generated a return of 18.1%, and are trading at an average multiple of 23 times earnings, compared with 17 times for the S&P 500 index as a whole," according toThe Economist.
However, there are those who think that the REIT fervor has gone too far, and that these dividend-producing vehicles have already peaked. Skeptics are convinced that there are a number of factors working against the recent performance of the REIT sector.
The threat of an impending interest rate increase, for example, looms heavily over the heads of those who remember 2013. Back then, all it took was the mention of a potential interest rate hike to drop REIT prices by as much as 13.5% over a period of just five weeks.
There are those, however, who are less worried about rate increases and more concerned about the rental market. Although it is safe to assume that rental trends have driven REITs forward, it would be wrong to ignore the possibility of the rental market reaching its peak sometime in the near future.
Supply has slowly been ticking upward in an attempt to keep up with demand, but the same demand that has allowed prices to skyrocket may start to lose some of its momentum as builders continue to mitigate the demand with more large-scale building projects.
Supply and demand is a delicate balance, but we should start to see a more balanced market as the recovery continues to move forward. As more buildings are introduced into the market, prices will likely drop.
Don't be surprised if builders add more apartment complexes to the renter pool by the end of the year than they were able to in the past decade.
"More than 320,000 new apartments are expected to be completed in 2016. That is a jump of 50 percent from 2015," according to new research from RENTCafe.
With inventory levels expected to increase exponentially, rents, and especially income from rents, will likely decline. The potential threat to REITs is very real but not one that would likely deter would-be investors.
Although skeptics have valid concerns, the state of the housing market continues to buttress the performance of REITs and should continue to do so for the foreseeable future for one simple reason: diversification
Despite skepticism, REITs appear to be much more resilient than they were when they declined in the past. It is important to note that REIT fundamentals are much stronger than they were in 2013 and 2008.
Most notably, REITs have collectively reduced their debt-asset ratio from about 70% to somewhere in the neighborhood of 31%.
What's more, REITs are much more diversified than they were just a few short years ago. Although ecommerce continues to dominate shopping trends, REITs have positioned themselves to weather the digital storm.
In fact, there are plenty of REITs increasing in value, as many online portals require warehouses to store their products. Over the course of last year, four of seven of the top-performing REITs had nothing to do with apartments at all but rather data centers.
Specializing in real estate of a digital nature, Digital Realty Trust actually owns and operates a global network of data centers that securely store data for a growing number of companies. So while they may not earn money in the same way that a typical REIT might, they are still capable of providing encouraging dividend returns.
It is worth noting, however, that Digital Realty Trust is the epitome of why the long-term prospects of REITs look encouraging: diversification. The very nature of its industry may not make Digital Realty Trust susceptible to impending rate increases or what those leave in their wake.
In fact, Digital Realty Trust is in a good enough position to not only weather the potential storm but to come out of it stronger than before.
For what it is worth, research this year from Morgan Stanleysupports the notion of a dramatic increase in the need for cloud-based storage.
As Digital Realty Trust's forte, Morgan Stanley's forecasts are encouraging to say the least.
According to research firm IDC, "worldwide spending on public cloud services will grow at a 19.4% compound annual growth rate -- almost six times the rate of overall IT spending growth -- from nearly $70 billion in 2015 to more than $141 billion in 2019."
Diversification, as has already been the case, should help REITs maintain their prominence for the foreseeable future, even with the threat of looming rate increases and the peak of the rental market on the horizon. REITs as a whole, should stand the test of time, given that diversification has and always will be one of the best ways to mitigate risk.
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.