Global REITs: Leaning into the recovery phase - Part 1
Article5 minutes09 September 2024
This article is part of a series, read Global REITs: Leaning into the recovery phase - part 2.
Since late May, the global REITs1 delivered a total return of 9.8%, outperforming the global equities index2 by 4.2%. We believe material catalysts remain for attractive global REIT performance from here.
In mid-April, we made the case that the global REIT sector was ripe with opportunity (see Global REITs – As the cycle turns, opportunities abound). After a period of slovenly performance as a rapid increase in interest rates meant capital finally had a cost, inflation was moderating and global REIT valuations appeared compelling.
With the market yet to price in the impact of lower rates, plus a few more factors discussed below, in late May we published the self-explanatory Global REITs – the most attractive sub-sectors.
Since then, the turnaround has been more rapid than many expected. In the three months from 1 June to 31 August 2024, global REITs1 have returned 12.6%, outperforming the global equities index2 by 7.8%.
If you’re wondering whether it’s too late to climb aboard the GREIT train, our answer is a definitive ‘no’. The engines may be rumbling but the train has yet to leave the station. Let me explain why.
The recent increase in global REIT performance reflects the now widely accepted view, aided by the U.S Federal Reserve flagging imminent interest rate cuts, that the multi-year inflationary outbreak was indeed transitory. It just took longer than expected to moderate.
Whilst this view is broadly understood, it is not in the least fully incorporated into global REITs. There are two reasons for this. First, whilst a rate reduction is now expected, it’s broader significance is not. A forthcoming US rate cut is more than that, signalling the transition from one interest rate operating regime to another. We are on the cusp of a new cycle.
Second, as this new cycle gets underway, we expect profound and positive impacts across the sector, with the potential to set many global REITs up for a multi-period run of outperformance as these groups leverage existing portfolio strength and robust balance sheets to invest for future growth.
The recent rebound in the global REIT sector’s absolute performance, and relative to equities is only the beginning in our view. As we said last April, it remains largely true that the share prices of select global REITs “continue to inhabit the old world and are yet to anticipate the new”. The train has not left the station.
This transition period is the opportunity and is currently in full view. History suggests that investments made before the market moves from one phase to another often prove the most profitable over the long term.
Of course, the future is uncertain and none of this is guaranteed. Here are the key ingredients for a successful transition:
- Inflation continues to fall - Evidence of moderating price pressures and sustained falls in the rate of inflation is what data-dependant central banks have been waiting for. If their data starts to suggest otherwise, future rate cuts could be delayed, elongating the transition.
- Lower finance costs – Lower rates have substantial implications for global REITs, reducing excess inflationary-era expense cost growth in real estate operations, insurances and financing.
- Attractive fundamentals – Performance will increasingly be driven by the ability to access both internal and external growth to drive earnings. As the chart below suggests, the sector’s earnings growth has the potential to materially exceed changes in developed market GDP, according to UBS estimates:
Global real estate sector earnings growth estimates vs. GDP growth*
Source: IBES, DataStream, UBS, DXAM
*Global EPS & GDP growth (YoY) is average of US, UK, EU, AU, JP, HK, and Singapore. Forecasts estimates are not guaranteed to occur
- Evidence portfolio valuations have bottomed – Results reported by several global REITs recently reported a much slower pace of valuation decline, or indeed increases, in recent June 2024 updates. This highlights an inflection point, as the final stages of cap rate softening are offset by top-line income growth.
Whilst these factors will be significant, our on-the-ground view offers encouraging reasons that the groundwork for the transition has been laid.
Fundamental operating results across many global REIT portfolios are showing strong occupancy levels and incremental tenant demand. The prospects for future rent increases are sound. On the supply side, commencements across select global REIT markets and sectors remains constrained. Both bode well for global REIT investors and the prospects for attractive ongoing performance.
With a range of investment opportunities and by leveraging their strong balance sheets, resilient and well managed global REIT portfolios are leaning into the recovery phase of the current market cycle. As regular readers will know, we have been positioning the Dexus Global REIT Fund to capitalise on opportunity in this transition for some time.
In part two, we’ll look at some key sectors and global REITs where we’re finding the most attractive opportunities.
References
1 GPR 250 REIT Index (AUD)
2 MSCI World Index (AUD)
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The Dexus Global REIT Fund (DXGRF) is an investment strategy for global listed property developed to target higher income with low relative risk while maintaining the real value of capital over the investment time horizon. The fund invests in the developed markets of North America, Europe and Asia.