Headwinds abound. With the effects of global geo-politics and rising rates being felt across all markets, there has been nowhere to hide and there has been a clear decline in transaction volumes and asset values. However, fund managers at Resolution Capital believe that global REITs are already pricing in much of the estimated loss of value to date, while private markets are not. They also see secular investment potential in areas of the market which present real opportunities for investors to access REITs at a discount to private market values – and also use them as an effective inflation hedge. 

This is according to Marco Colantonio, co-portfolio manager for the Nedgroup Investments Global Property Fund, who presented at the recent Nedgroup Investments Global Fund Manager Workshop. 

Global REITs reflecting market weakness 

In the falling markets of 2022, Global REITs have disappointingly underperformed Global Equity, reflective of investors’ misconceptions about the effects of rising rates on listed property. 

However, in terms of operating conditions in markets, Colantonio says he believes the leasing fundamentals are relatively stable, with the key areas of weakness presenting in asset markets with asset values coming under pressure. 

“Interestingly, listed REITs have already reflected a lot of that and are currently trading at about 20% discount to unlevered asset values, while the private market values, which typically lag, have not reflected the rapid change in the pricing environment,” he says. 

Colantonio points to the current volatility as a function of liquidity in listed markets.

“This is in stark contrast to the unlisted markets where once again we are beginning to see some of the unlisted property funds in the UK restrict redemptions. This suggests that, although they are reflecting stable asset prices, they have not marked to market the underlying asset prices, whereas listed property funds have.” 

REITs as an inflation hedge 

In rising rates environments, Colantonio says it’s important to remember that over the last 25 years, REITs have been able to generate income growth greater than core inflation. This is a result of leases that are directly linked to CPI or contractual fixed-rental increases ranging between 1-4% per annum which is helping to grow revenues in the short-term. 

In the medium term, rising construction costs are also contributing to higher rents as, simplistically, developers need to justify the costs of building with higher rental agreements. Other factors like increasing labour costs and delays in building projects are also contributing to fewer competitive developments being built, increasing demand for existing real estate assets. 

“Of course, these pre-conditions for higher rental income rely on the fundamental drivers of the global real estate market: leverage, supply and demand,” says Colantonio. 

Demand: REIT occupancy, which is proxy for demand is at an all-time high in the US. “If we enter into a recessionary environment – REITs, fortunately, will do so from a very good occupancy position,” explains Colantonio. 

Supply: “Meanwhile, construction levels as a percentage of inventory in the US are relatively in line with the long-term average whereas previous property market downturns have typically been preceded with elevated levels of supply,” he says. 

Leverage: Colantonio credits this as the most important indicator for real estate. He says leverage is moderate across most REIT markets, with many REITs maintaining lower levels of leverage, having learnt their lesson from the global financial crisis. Pockets of concern persist in Europe, Singapore and Japan. 

Areas of opportunity 

Three areas of opportunity that are demonstrating an attractive mix of these pre-conditions for higher rental income have been grouped into the themes “Beds, Meds and Sheds” by Colantonio and his team. Portfolio holdings playing to these themes currently make up more than 60% of the Nedgroup Investments Global Property Fund. 

Beds: This refers to rental housing across a range of formats including single and multi-family housing which is experiencing strong rent growth in the US, and manufactured and student housing which are typically resilient during economic downturns. 

Meds: In light of the globally aging population this refers to exposures in seniors housing and also life science labs, doctors’ clinic and medical office buildings. 

Sheds: This is related to e-commerce, logistics and digitisation including real estate like data centres and towers. 

Outlook – conditions right for REITs to deliver strong returns 

There are clearly many headwinds to face including policy error, geopolitical risk and interest rate effects. However, Colantonio says REITs are relatively well-positioned with moderate supply and rising construction costs, secular demand withstanding (particularly in beds, meds and sheds), strong balance sheets and, importantly good liquidity for investors in high quality portfolios. 

Given that REIT prices are trading at a discount to appraisal values, listed REITs represent relatively good value compared to private markets and unlisted property funds. Combined with an attractive dividend yield and the potential for rental increases to combat inflation, there is a compelling argument for REITs to form part of a diversified global investment portfolio, irrespective of the global economic environment. 

For more information about the Nedgroup Investments Global Property Fund visit the fund page here.