As markets start to price in the end of rate hikes and the beginning of rate cuts, what was once the worst performing sectors has flipped to one of the best.
Over the past three months, the real estate sector has been one of the few sub-sectors to outperform the wider S&P 500 index and match the pace of the S&P 500 IT sector made up of the outperforming ‘Magnificent 7’.
This is a quick turnaround after being one of the worst performing sectors of 2022 and for most of 2023 when interest rates were rising.
Not long ago, the real estate market looked to be grinding to a complete halt with high mortgage rate levels and a bleak commercial property outlook with vacancy rates stubbornly elevated after the pandemic.
But as rates look like they might be starting to fall in 2024 and beyond, Tim Gibson, Janus Henderson’s co-head of global property equities, told FSA he has been suggesting clients avoid “standing in the way of the Fed”.
When the Fed raised interest rates at the quickest pace in 40 years, property equities and REITs were one of the worst performing sectors.
But now that the direction of rates has changed, it should be positive for the real estate sector which was so badly beaten up in 2022 and most of 2023.
Gibson (pictured) said as active managers, his firm is now switching out of the sectors of real estate that were favoured during rate hikes into those which were the most badly hit.
“The reason that rates were rising is because we had inflation,” he said. “If you had super long leases, that was the worst thing you could own because you’re exposed to those longer duration assets.”
“You wanted to be in sectors where you could basically change your revenue stream overnight: hotels are a good example, as you can change the room rate pretty quickly.”
Now, he said investors looking at the real estate sector need to position in the opposite direction.
“You want to be going overweight long duration assets and you want to be going underweight short duration assets,” he explained.
Gibson said long-duration real estate assets such as open air shopping centres or those with triple net leases look attractive in this environment.
Whereas hotels and self-storage – both worked well during rising inflation and interest rate environment – won’t do so well in this upcoming rate down-cycle.
“You want to be underweight sectors which have short duration because they’re going to be able to mark-to-market a little quicker on the way down,” he said.
“Self-storage can reprice almost on a daily basis, and the fundamentals are weak because the US housing market has frozen and you don’t have people moving or using self-storage,” he explained.
“I wouldn’t want to be underweight Japan”
However the Japanese real estate market has a different relationship with interest rates and inflation, both of which are finally trending upwards.
Japan is the second largest region in the MSCI World IMI Core Real Estate Index after the US and has been growing in popularity amongst global investors.
Gibson said: “What real estate market can you go to globally, where the yield you’re getting for your assets are higher than your cost of debt?”
“I think Japan is at the moment is probably one of the only markets globally that you could do that. I wouldn’t want to be underweight Japan.”
As such, he has taken up positions in hotel companies in the Japanese REIT space, as well as Japanese developers.
“If you’re getting inflation in Japan, you want to be in Japanese real estate,” Gibson added.
“You’ve got almost the perfect storm for Japanese property developers.”
