How can REITs play a role in helping investors navigate the current macro environment?
Despite geopolitical tensions and concerns around tightening monetary policy from central banks, we continue to believe that investors’ desire for income and real assets to help protect from the threat of sustained inflation will remain supportive for physical real estate. Historically, the Fed raising rates has not necessarily been a negative catalyst for REIT market performance. Correlation between bond yields and listed real estate returns is also very low. Real estate operates as the ‘landlords of the economy’ whose income streams benefit from positive economic growth. As long as higher rates are a symptom of higher economic growth and inflation, property will benefit from this higher rental growth, which will offset the impact of higher bond yields.
REITs typically perform well during periods of high inflation and rising growth and there has been a strong correlation between inflation expectations and REIT returns. However, inflation without pricing power is fairly meaningless. Tenants can’t simply ‘pay more rent’ if their underlying businesses are struggling. This is why it is important to be selective and own those businesses/sectors which can increase rents due to a favourable supply/demand backdrop.
Real estate is one of the few ‘real’ asset classes to invest in and has been largely ignored over the past number of years as investors have not have to worry about inflation. Therefore, we believe real estate offering predictable and growing inflation linked cash flows makes it an attractive relative income proposition, especially against the current macro backdrop.
Which markets offer the greatest potential for REITs and why?
Given the unusual level of dispersion by countries last year largely due to the varying speed of emerging from the Covid crisis as vaccinations and re-opening of economies in Asia Pacific has generally lagged the West, there is probably more scope for the region to play catch up this year. APAC has underperformed global REITs and US REITs by 29% and 46% respectively since ‘vaccine Monday’ in November 2019 and most of the drag came from the re-opening sectors like retail and hotel which has ample room to rebound as countries recover from the cyclical damage from the pandemic and return to a path of sustainable growth. Valuations today remains attractive and Asia Pacific is still trading well below pre-Covid levels. From a rising rate perspective, Asian central banks are also under less pressure to pivot towards outright tightening due to a having a more moderate inflation and subdued domestic economic backdrop.
Longer term, there is also the future growth opportunities of REITs as more Asian countries adopt REIT regimes. Today, the Asian listed property market is approx. $1.6 trillion of which a quarter is REITs. The physical commercial real estate market is more than $10 trillion so we expect there to be more exciting new investment opportunities into the growing REIT markets in Asia as is evident from the success of the rollout of REITs in India, Philippines and more recently China.
Are REITs sustainable?
Over the past two decades, listed global property has generated total returns of 9.6% per annum, stronger than general equities and fixed income alternatives and two thirds of the global REIT returns have come from reinvested dividends. The sector’s attractive and differentiated return profile comes from a combination of high starting yield, inflation linked earnings growth and price appreciation from a real physical asset supporting the case for sustainability of those returns over the longer term. There are diversification benefits with lower correlations to many other asset classes and the additional benefits of portfolio enhancement by increasing risk-adjusted returns within a balanced portfolio by adding REITs makes the case for investing in the asset class regardless of market conditions.
The Fund Selector Asia Investment Forum Singapore was held on 15 March 2022 and was sponsored by Columbia Threadneedle Investments, Janus Henderson Investors, J O Hambro Capital Management and Jupiter Asset Management.
Find out more about what was discussed and the strategies that were presented here: https://fundselectorasia.com/events/fund-selector-asia-singapore/