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During the Federal Reserve’s interest rate hike policy, listed REITs found themselves in a difficult situation. The total return of the FTSE Nareit All Equity index decreased by 24.95% in 2022 and was in negative territory for most of 2023. However, as the direction of monetary policy changed, REITs rebounded and the index ended 2023 with an increase of 11.36%. REITs continue to lag the broader stock market, with the S&P 500 up 26.3%.
This trend began to reverse in the second half of 2023, with REITs posting a 17.9% return in the fourth quarter. REIT fund managers say this situation is likely to continue into 2024 as a combination of factors creates a favorable environment for the sector. However, as of Dec. 29, public equity REITs were trading at a median discount of 10.7% to consensus NAV per share, according to S&P Global Market Intelligence, indicating room for further recovery. .
Laurel Darkay said: “This is an element of interest rate stability and an attractive valuation element for the sector, particularly those that have taken a more defensive stance or those that have shown strong long-term growth to support demand. The fact is that we are seeing growth.” Managing Director and Head of Global Listed Real Estate Assets at Morgan Stanley Investment Management.
When global asset management firm Nuveen completed its investment outlook for 2024, “the REIT sector was one of our top priorities,” said Saira Malik, chief investment officer at Nuveen. said.
solid foundation
When it comes to portfolio fundamentals such as occupancy, rental income growth, and debt ratios, many publicly traded REITs will be He is said to be in a healthy condition already. With Fidelity. But all the headlines about a “commercial real estate crisis” caused primarily by troubles in the office sector have made investors wary of putting money into REITs.
“The problem with REITs is, in a sense, the baby was thrown out with the bathwater,” Malik said. “A lot of people are worried about the office sector, so people are like, ‘Why would I want to own anything related to real estate, whether public or private?'” But if you look at the REIT benchmark, the office sector is It tends to be less than 5% of the benchmark. ”
For issues that could threaten U.S. commercial real estate performance, such as liquidity concerns, a downturn in the investment sales market, rising costs of capital, and the possibility of a recession, publicly traded REIT stocks already have those factors. It’s woven into it. Richard Hill, senior vice president and head of real estate strategy and research at Cohen & Steers, a global investment management firm specializing in real estate, points out:
“We’re creating a situation where real estate securities are valued very attractively,” Darkay said. “REITs are undervaluing themselves and private real estate.”
Hill said this is an attractive entry point for investors, especially since publicly traded REITs tend to deliver the best returns early in the real estate recovery cycle, and according to previous research from Cohen & Steers, In some cases, it can exceed 20%. Despite the REIT’s fourth-quarter rally, its total return is still about 16% below its historical peak, Hill noted. Cohen & Steers expects the sector’s returns to be in the 10% to 13% range if the Fed can achieve a soft landing for the U.S. economy this year. AEW Capital Management expects REIT total returns to be about 25% over the next two years, said Gina Szymanski, managing director and portfolio manager of AEW Capital Management’s North American real estate securities group. , this will be around low double digits by 2024. . This is based on a current dividend yield of 4% and a growth rate of 6%. Expectations would rise if the Fed cuts rates before the end of the year, as it hinted at at its December meeting.
Typically, REITs deliver returns between 4% and 10%, Szymanski said, between bonds and stocks. “I would say the outlook for this year is higher than what REITs typically do,” he said. “And if we have it, it will increase even more. [Fed] pivot. “
Good Omens
Currently, most investment management companies wealthmanagement.com He said a rate cut is unlikely at the March Fed meeting as the U.S. economy continues to show resilience. They expect rates to stabilize in the first half of this year, followed by some modest rate cuts in the second half of 2024. Malik said the Fed will likely cut rates three or four times over time to try to stabilize real interest rates. Szymanski noted that both interest rate suspensions and rate cuts tend to create a favorable environment for publicly traded REITs. Stable interest rates allow him to limit fluctuations in REIT valuations, while lower debt costs allow REITs to take advantage of new acquisition opportunities at the same time as private market prices decline. (Hill estimates that private real estate valuations are about 50% of the way to final valuation). Hill pointed to how similar situations played out in the early 2000s and from 2010 to 2014 after the Great Financial Crisis.
In his view, even a recession doesn’t necessarily destroy the positive outlook for publicly traded REITs. In that scenario, REITs would deliver near-zero returns, but “relatively, they would significantly outperform the S&P 500,” he noted.
Additionally, a recession will hurt REIT real estate fundamentals, while forcing the Fed to cut rates more quickly, Szymanski said. “So you’re back to a positive outlook right away.”
winners and losers
Of course, there are more than a dozen real estate subsectors within the REIT industry, and financial advisors must keep in mind that even in a favorable environment, not everything will work out. Factors to consider include whether the types of properties owned by the REIT have the potential for stable long-term growth in lease and rental rates and whether demand for these properties currently exceeds supply. It is included.
For example, data center REITs are likely to be on every investment manager’s recommendation list, as demand for data centers is likely to increase for years to come due to the growth of new technologies. At the same time, electricity availability issues previously limited the amount of new supply that could be added to that market. This not only means the REIT has the opportunity to expand its portfolio by adding new data centers in the future, but also allows it to aggressively increase rents “for the first time in 10 years,” Darkay noted.
Senior housing REITs were also popular due to favorable demographic trends. The youngest baby boomers are at an age when many are starting to move into senior housing, and supply to the sector has been severely cut in the wake of the coronavirus pandemic. Additionally, senior housing has become increasingly upscale in recent years, “with more activities, more amenities. That makes them more attractive to people at an earlier age.” Malik says.
REITs that own and operate single-family rental properties (SFRs) should benefit from a lack of single-family homes for sale, rising mortgage rates, and rising home prices. Durkay noted that currently buying a home is nearly 50% more expensive than renting, so demand for SFR units will increase well beyond 2024.
The sector that stands to benefit the most from lower interest rates is net lease REITs, according to Hill and Derkay. Derkay noted that total returns within this sector tend to be highly negatively correlated with rising interest rates. Given that most net-lease REIT portfolios tend to be near-full and reliant on credit-rated tenants, lower interest rates would allow for significant future revenue growth.
The near-term outlook is less favorable for apartment and industrial REITs, two sectors that have been favorites of investors for the past few years. While both real estate sectors continue to benefit from long-term demand factors, new supply has exceeded demand so far this year. Any potential short-term underperformance, particularly in the industrial sector, will have more to do with inflated growth expectations than real estate-level challenges, Hill said. “If growth turns out to be really good instead of really good, we think multiples could come under pressure,” he said.
Moreover, despite their recent rally (total return increased 19.6% in December), office REITs continue to show warning signs for investment managers. There’s the issue of persistent vacancies and the fact that office occupancy remains at about 50% of pre-pandemic levels, Darkay said. There are concerns that remote working will become as easy as the technology that powers data centers advances. Additionally, office REITs could face financing problems as the sector’s valuations decline.
“If you look at office demand, I think it will be negative. It will hurt the overall occupancy, it will hurt the overall rent level, and that will ultimately hurt the overall value of this property. ”Darkay said. “As a loan approaches its due date, the value of the debt will often exceed the value of the property. It’s not just a question of demand and fundamentals, it’s also a question of balance sheet and value. I think, therefore, the outlook that I have for the US office in particular is unfavorable in the long term.”
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