Listed real estate: Taking comfort from REITs’ strong position amid challenging markets
Co-Head of Global Property Equities, Guy Barnard, discusses the reasons why the team sees a more optimistic outlook for listed REITs for the remainder of the year and into 2024.
4 minute watch
- Despite negativity surrounding real estate, global listed REITs returns are flat year-to-date having taken their write-downs in 2022. The team continues to see generally high levels of occupancy and continued rental growth within the asset class.
- Listed REITs have very low leverage levels compared to history and enjoy continued access to funding via unsecured debt, enabling them to take advantage of arising opportunities.
- Forecast earnings growth of 5% in 2023 for US listed REITs versus a decline for broader equities, and attractive valuations provide further justification for the team’s more constructive view.
Exhibit 1: S&P 500 annual earnings change vs. price change (%)
REITs or Real Estate Investment Trusts invest in real estate, through direct ownership of property assets, property shares or mortgages. As they are listed on a stock exchange, REITs are usually highly liquid and trade like shares.
Real estate securities, including Real Estate Investment Trusts (REITs) may be subject to additional risks, including interest rate, management, tax, economic, environmental and concentration risks.
As we approach the halfway point of 2023, commercial real estate has continued to make the headlines, with concerns shifting from the cost of finance, in the wake of interest hikes, to concerns around the availability of credit for real estate in the wake of the banking crisis in the US, and with concerns around, in particular, the US office sector.
Now, despite those headlines and the challenges, global REITs [real estate investment trusts] find themselves largely unchanged, year-to-date (27 June 2023),1 again reflecting our view that a lot of repricing that was required in real estate took place very quickly in the listed REIT market over the course of 2022.
In our discussions with clients, we’ve really tried to focus on three key themes. Firstly is just a need to look beyond those headlines. There are, undoubtedly, challenges in parts of the real estate sector, and the US office market is facing a very acute situation with vacancy rates of [almost] 30% in many of the key gateway cities, but this is an area of the market that we can easily avoid in the listed real estate market. And many other areas of the market continue to demonstrate very strong and robust earnings and rental growth.
As funding costs rise, listed REITS can benefit from lower leverage and wider access to funding
Secondly, from a funding side, there are clearly going to be winners and losers, and we think that the REIT sector is going to be one of the winners from the current situation. Leverage levels are very low, relative to history and in absolute terms,2 and REITs have continued to prove that they have access to debt through the unsecured bond markets at spreads [rates] and pricing that is still reasonable and accretive to their overall business models.
So we’re increasingly excited about the opportunities for REITs to benefit from some of the challenges of others, particularly more leveraged and private owners of real estate, and to consolidate as a proportion of the overall real estate market.
REITs are exhibiting operational resilience and their earnings are forecasted to grow
Secondly, I think the importance of operational resilience is clearly going to come to the fore as we move through the next phase of the cycle. Here, again, when we speak to the companies in which we invest, we continue to see generally very high levels of occupancy and continued rental growth, which continues to feed into earnings and dividend growth for us as investors.
So when we look at the earnings growth forecast for the US REIT sector this year of 5%, and continued growth in 2024,3 we think this looks attractive relative to the wider [equities] market, where earnings are now forecast to decline, and perhaps has been underappreciated when we look at share price performance over the last year or so.
And finally, the macro narrative has clearly been a significant headwind for the REIT sector over the last 18 months. The impact of rising interest rates and bond yields is clearly having a negative impact on underlying real estate pricing. That is taking time to feed into private real estate values, but as I said earlier, very quickly fed into the real estate values of the listed REIT market, which is priced by stock markets on a daily basis.
Listed REITs look well positioned for a potential recovery
Now, as we move forwards, I think it’s fair to say we’ve broken the back of the interest rate hiking cycle. Let’s see if a pause is next month or after the summer, but I think we are getting to that phase. And at the end of a Fed [US Federal Reserve] hike cycle, history suggests it’s actually been a good time to look at the REIT sector, both in terms of the performance that is generated in absolute terms but also relative to the wider equity market,4 particularly given that dependability of cash flows that I spoke to earlier.
So I think there are reasons to be more optimistic as we move through the rest of 2023 and into 2024. We continue to see some very compelling valuations in the REIT sector, with companies trading at a discount to the inherent value of their buildings, even adjusting for the repricing that was necessary in the wake of interest rate hikes. And I think this leaves us in a good position as we think about the opportunities and the returns that we can generate from here. Thank you.
1 Bloomberg, FTSE EPRA NAREIT Developed Total Return Index USD (global REITs) as at 27 June 2023.
2 Green Street, Morgan Stanley, Janus Henderson Investors analysis, as at 31 December 2022.
3 FTSE Russell, S&P Global Indices, Bloomberg, Janus Henderson Investors Analysis, as at 14 May 2023. There is no guarantee that past trends will continue, or forecasts will be realised.
4 UBS, Refinitiv Datastream, Janus Henderson Investors analysis, total returns in USD 31 December 1990 to 31 December 2022. Global REITs = FTSE EPRA Nareit Developed Index; global equities = MSCI World Index. Data from 1991.
Past performance does not predict future returns.
Bond yield: level of income on a security, typically expressed as a percentage rate. For a bond,this is calculated as the coupon payment divided by the current bond price. Lower bond yields means higher bond prices and vice versa.
Leverage: the amount of debt that a REIT carries. The leverage ratio is measured as the ratio of debt to total assets.
Loan-to-Value (LTV) ratio: calculated by dividing property loan amount by the property value. Used by lenders to assess the level of risk exposure when underwriting a loan/debt.
Unsecured bonds: debt that is not backed by collateral, as such they are higher risk and carry higher interest rates.
FTSE EPRA Nareit Developed Index tracks the performance of real estate companies and real estate investment trusts (REITs) from developed market countries.