Expecting U.S. Growth to Slow? REIT Pair Trade Pays 1.6%

Investors who see a slowdown for the U.S. economy may be interested in a strategy of being long Health Care REIT Inc. and short Simon Property Group Inc.

Health Care REIT, the largest U.S. health-care landlord by market value, is up 32 percent since Dec. 19, outpacing the 22 percent gain for Simon Property, the biggest U.S. owner of shopping malls. Their stock-price ratio is rising from an all-time low -- see chart. Health Care REIT shares closed at $69.21 yesterday, while Simon Property was at $175.98.

U.S. gross domestic product is forecast to grow 2.2 percent this year, down from 2.8 percent in January, based on the media estimate of economists surveyed by Bloomberg.

This pair trade may appeal to investors with a contrarian outlook about the expansion, said Lance Roberts, who helps oversee $600 million as chief strategist for STA Wealth in Houston. That’s because it combines a defensive stock with one that’s pro-growth, offering a way to express a more skeptical view about the economy, he said.

- Health Care REIT, based in Toledo, Ohio, is considered countercyclical because it benefits from a “forced spending cycle” on medical-related expenses for an increasing number of older Americans, Roberts said. Indianapolis-based Simon Property is “leveraged to overstretched consumers,” so it’s more dependent on strong economic gains.

- U.S. GDP will expand 3 percent next year, according to the Bloomberg survey, though that projection could be “overstated,” particularly as millions of Americans still are out of work and haven’t benefited from the post-recession recovery, he said.

This pair trade “pays investors to wait” because the dividend yield for Health Care REIT -- the long position in the strategy -- is bigger than the shorted stock’s, Roberts said.

- The yield for Health Care REIT is 4.6 percent, compared with almost 3 percent for Simon Property, resulting in a positive differential of 1.6 percent, according to data compiled by Bloomberg.

The ratio historically has increased leading up to and during U.S. recessions -- see chart, and its year-to-date performance is reminiscent of 2006-2007 when it rose ahead of “massive” gains coinciding with the 18-month slump that began in December 2007, said Jim Stellakis, founder and director of research at Technical Alpha Inc. in Greenwich, Connecticut.

Traders increasingly shifting money into Health Care REIT and out of Simon Property illustrates some skepticism about economic growth that isn’t reflected by analysts’ recommendations yet, he said.

- 38 percent of analysts have a buy recommendation on Health Care REIT, compared with 79 percent for Simon Property, the data compiled by Bloomberg show.

- The price target for Health Care REIT -- at $66.83 for the next 12 months -- is 3.4 percent lower than its current share price, whereas Simon Property’s $191.72 target reflects an 8.9 percent increase, based on the consensus of analysts’ forecasts.

Some investors may be dissuaded by Health Care REIT’s valuation, said James Sullivan, an analyst at Cowen & Co. This stock currently is trading at a 24 percent premium to his estimate of net asset value per share, compared with a 0.2 percent discount for Simon Property.

- For this trade to work, the yield on 10-year Treasuries, currently at 2.3 percent, will need to fall more, after declining from a two-year high of 3.03 percent on Dec. 31.

- There are some economic data -- including housing sales, manufacturing and hiring -- that should continue to benefit the shopping-mall operator.

Still, more downward revisions to GDP forecasts “don’t bode well for Simon Property,” particularly given that the recovery is one of the longest in history and the Federal Reserve is completing its unprecedented quantitative-easing program, Roberts said.

- As a result, this pair trade “makes excellent sense” for investors with a more skeptical economic outlook because of the ratio’s upside potential and attractive yield differential.

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