Menu Close

Bank of America Eyes Small-Cap Real Estate Investments

Bank of America (NYSE:BAC) analysts appear to believe that the high dividend yields of small-cap real estate assets could see them outperform in the long-term. I will admit, I find this call surprising. Let’s look at the rationale behind it all and whether or not it makes sense in the context of the current economy.

The bank’s rationale

According to Bank of America analysts led by Jill Carey Hall, U.S. Equity Strategist and Head of U.S. Small/Mid Cap Strategy at Bank of America Merill Lynch, REITs now provide “the highest distribution yield of any small cap sector.” They wrote, “We have continued to highlight the importance of dividends in the current backdrop, where we have seen wide performance spreads between dividend payers vs. non-payers with small caps, and dividend yield has been the best stock selection factor within small caps year-to-date.” Lastly, they claim that the easing of supply chain backlogs and the restocking of companies could see industrial REITs as the asset class’ breadwinners.

Is it a good time to invest in real estate?

Personally, I believe that one could make an argument that investors tend to favor high-dividend assets during economic contractions which could support Bank of America’s thesis. Furthermore, their small-cap claim is bound to a “late-cycle” statistical observation which historically has seen small-caps outperform 60% of the time in this part of the economic cycle.

Bank of America Eyes Small-Cap Real Estate Investments

Source: KoyFin

However, just because the market favors high-dividend stocks doesn’t mean all high-dividend stocks will outperform. Real estate is significantly more cyclical than other high-dividend stocks, such as consumer defensive stocks and health care stocks. This calls into question whether the dividend yields of REITs will be sustained during the ongoing recession.

Another fault line concerns the “late-stage” cycle. Usually, I’d agree that the late-stage cycle means that we’re likely to see a reduction in interest rates to re-stimulate the economy. However, the current yield curve conveys bearish flattening, aligning with a prolonged stagnation of the economy, which could drive down industrial, hotel and residential real estate prices.

The most recent housing data by the U.S. Census Bureau reveals a 9.6% monthly decline in housing starts in July, while building permits slumped by 1.3%. In light of the most recent data, I believe it’s clear that the sector has reached a cyclical peak. As such, I think the argument that real estate prices will hold strong in the short to medium-term is doubtful.

Concluding thoughts

Based on recent statements, Bank of America is bullish on small-cap REITs. However, I believe the bank’s fundamental claims aren’t aligned with the current economic facts. I predict that the prices of real estate could soon decline, which could put a dent in REIT dividend yields.

This article first appeared on GuruFocus.