Why invest in listed REITs today

 

Mathew Kirschner, CFA

Portfolio Manager, U.S. Real Estate

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4 minute read

April 2024

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REITs have outperformed stocks and bonds when yields and growth move lower. Demand is healthy while supply is constrained. And REIT valuations relative to the broader equity market are meaningfully below the historical median.

KEY TAKEAWAYS

  • There are three key reasons to invest in listed REITs right now, starting with the fact that REITs have outperformed stocks and bonds when yields and growth move lower.
  • Demand is healthy while supply is constrained, and REIT valuations relative to the broader equity market are meaningfully below the historical median.
  • When it comes to specific property sectors, we favor those with pricing power, or the sustained ability to command higher rents.

Turning to the case for investing in REITs right now, we think it comes down to three reasons.

First, REITs have outperformed stocks and bonds when yields and growth move lower, which is important to note given we believe that the rate-hiking cycle is likely ending and growth is likely to slow.

U.S. REITs have delivered 19.5 percent average annualized monthly returns in periods when both growth and yields have declined.

EXHIBIT 1
Lower growth and lower yields have been a favorable backdrop for listed REITs

Average annualized monthly total returns, January 1990 – December 2023(1)

Lower growth and lower yields have been a favorable backdrop for listed REITs

That’s particularly notable given we believe we are shifting away from a period of slowing growth and higher yields when REITs have underperformed.

Second, demand is healthy, albeit decelerating as the economy slows, but cash flows remain relatively strong and resilient.

Supply, on the other hand is constrained amid higher rates, tightening lending standards, and collapsing developer profit margins.

EXHIBIT 2
REIT valuations vs. equities are meaningfully below the historical median

U.S. real estate vs. U.S. equities multiple spreads(1)
January 2005 – February 2024

REIT valuations vs. equities are meaningfully below the historical median

Third, REIT valuations relative to the broader equity market are meaningfully below the historical median.

The current spread between U.S. REITs and U.S. equities of -1.1x is at a level only recently seen at the peak of the pandemic and also in the wake of the financial crisis.

EXHIBIT 3
Increased home ownership costs and demographic trends support single family for rent

Homeownership affordability nationally is to the lowest level in the last decade
January 2003 – December 2023

Increased home ownership costs and demographic trends support single family for rent

When it comes to specific property sectors, we favor those with pricing power, or the sustained ability to command higher rents.

Supply and demand are the key drivers here.

One major factor is demographic shifts.

For instance, there are segments of the housing rental market where demand is high as millennials hit an age where they are seeking more space and good school districts to raise families.

But home ownership affordability is at its lowest level in a decade.

EXHIBIT 4
Data centers experiencing record fundamentals
Data centers experiencing record fundamentals

Similarly focused on demographics, senior housing should see strong longer-term occupancies and cash flow as high demand meets lagging supply.

The proportion of the population over 80 is climbing, while supply in senior housing is 70 percent below its peak.

Cloud computing, streaming, social media, and gaming are notable secular shifts that have already been driving demand.

Artificial intelligence is accelerating that trend.

That is a key reason data centers are seeing rental growth on average around 20 percent and very low vacancy rates.

Another key point in our outlook is that listed REITs have been net sellers of assets since 2015.

But we expect this to shift.

During 2000 to 2004 and again in 2010 to 2014, listed REITs net acquired assets as premiums to net asset value afforded them an attractive cost of capital.

EXHIBIT 5
Listed REITs have historically acquired assets in similar market conditions
Listed REITs have historically acquired assets in similar market conditions

We think this scenario can happen again.

The listed markets leads private in asset value recovery, while higher financing costs, more restrictive lending and slowing growth will likely add to pricing pressure in the private market.

REITs, which primarily finance themselves in the corporate unsecured market not the bank market, should be able to take advantage of acquisition opportunities given their access to cheaper debt and equity.

We believe this should contribute to a favorable environment for REITs.

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ABOUT THE AUTHORS
Author Profile Picture

Mathew Kirschner, CFA, Senior Vice President, is a portfolio manager for U.S. real estate securities portfolios.

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