With oil prices cooling off recently, taking energy stocks down with them, real estate has emerged as the best-performing sector of 2021. As of late July, real estate stocks were up 23.8% on the year, outpacing energy -- up 22.7% -- and the broader S&P 500's more than 15% gain.
Real estate investment trusts (REITs) have helped lead that charge. Through the end of June, the average REIT had generated a more than 21% total return, led by self-storage, retail, and residential. Here's a closer look at what's driving those top-performing sectors.
Strong market conditions
Self-storage REITs have been red-hot this year, with the five publicly traded operators generating total returns between 35.6% and 47.4%, led by Extra Space Storage (NYSE: EXR). That continued the sector's strong showing as it delivered a 12.2% total return in 2020, second only to data center REITs at 21%.
Fueling those outsized returns has been robust growth from self-storage operators as they benefit from strong occupancy levels, giving them pricing power to raise rental rates. Extra Space Storage is off to a great start in 2021, as it had the highest first-quarter occupancy level in its history at 95.7%.
That drove strong same-store net operating income (NOI) growth of 6.5%, which, when combined with its growing portfolio, propelled a 21% increase in funds from operations (FFO) per share. With the REIT already at record occupancy, it can continue raising rates as it heads into the summer leasing season when more people need storage space. Because of that, shares of self-storage REITs like Extra Space could have further to run.
Retail REITs have enjoyed a bounce-back year, with the average one rallying nearly 33% through the end of June. That's a dramatic improvement from last year when retail REITs produced a negative 25.2% total return. Driving that recovery has been improved sales in physical retailers, thanks to government stimulus and the vaccine rollout giving consumers the cash and confidence to go shopping.
That, in turn, is giving retailers the money to catch up on their rental payments. Further, it's allowing retail landlords to raise rents as retail rates grew 2.3% in May, after falling for most of last year.
Another factor fueling the rally in retail REITs has been an uptick in mergers and acquisitions activity. Kimco Realty (NYSE: KIM) and Weingarten Realty Investors (NYSE: WRI) are joining forces to create the largest REIT focused on open-air, grocery-anchored shopping centers. Meanwhile, Kite Realty (NYSE: KRG) is combining with Retail Properties of America (NYSE: RPAI) to become the fifth-largest shopping center REIT.
Those deals drove up the stock prices of the acquisition target while helping lift values across the entire sector as investors anticipate more consolidation in the space. If more deals come, it could drive additional gains for retail REITs.
Apartment buildings are filling back up
Residential REITs have also rallied this year, with the average one up more than 27% through the end of June. REITs focused on apartments are starting to see demand bounce back following some pandemic-related headwinds as workers return to the office. Nationwide apartment rental rates surged 10.1% year over year in May, outpacing the blistering growth of industrial real estate, which rose 9.5% that month.
That's benefiting apartment-focused REITs like AvalonBay Communities (NYSE: AVB) and Camden Property (NYSE: CPT). AvalonBay's physical occupancy was up to 96% in May from 93.9% in Q4 2020, while asking rent surged 14%. Meanwhile, Camden reported that same-property occupancy had risen from 96% in Q1 to 97% in May.
The REIT also noted that blended lease rates -- a combination of new and expiring rates -- have improved from 1.2% above expiring leases during Q1 to 7.7% in May. Those improving market conditions have helped drive more than 40% total returns for AvalonBay and Camden Property investors this year. If apartment demand remains strong, residential REITs could continue rallying.
Real estate's rally could continue
Real estate has emerged as the best-performing sector of 2021 as demand recovers from the pandemic. It's still in the early days of that rebound, suggesting REITs could have further to run. Because of that, investors should take a closer look at the sector, starting with these top REITs.