Global REITs: Leaning into the recovery phase - Part 2

North American opportunities

We have long argued that Canada is the fund’s secret weapon. Canadian seniors housing owner- operator Chartwell Retirement Residences (TSX:CSH) is a good example of the opportunities you simply can’t access in Australia.

Due to higher construction and finance costs, supply of new seniors’ housing is constrained while an ageing population is driving demand. Company management recently claimed this presented the best conditions for its portfolio and the wider sector on record. With occupancy at around 85%, management expects this figure to increase to 90-95%. This expectation is not currently priced into the company’s shares.

The same is true of US multi-family REIT AvalonBay Communities (NYSE:AVB), a market leader in the ownership, development and operation of high-quality apartment buildings in mainly coastal gateway cities. Its earnings update showed the portfolio leading in same-property net operating income (NOI) growth and rental growth. With attractive supply and demand dynamics, there are many value-accretive opportunities for new developments.

Targeting rental tension in Asia Pacific

Singapore-listed Data Centre REIT Keppel DC (SGX:KDCREIT) recently highlighted the strong embedded growth in its Singaporean portfolio. Due to its geographic location and approach to data sovereignty, the country’s data centre sector has strong demand and limited supply. This has resulted in a very tight market, personified by the company’s major tenant recently signing a lease at a 40% rental premium to its previous agreement. 

Across the South China Sea, Japan is experiencing strong tourist demand and a weaker currency, which is benefiting Japan Hotel REIT Investment Corporation (TSE:8985). Assisted by lower-than-expected operating costs, the company’s reported earnings were ahead of initial forecasts. On a like-for-like basis, across the portfolio NOI was up 24.5%. With international and domestic tourism accelerating, this is unlikely to be a one-off.

Asset valuations bottom in Europe

During the recent reporting season, European and UK REITs announced a much slower pace of valuation decline. This suggests that asset valuations in the region have finally bottomed. Indeed, some REITs are reporting increases. As the final stages of minimal cap rate softening are offset or even exceeded by top-line income growth, we’re at an inflection point from which we expect the Dexus Global REIT Fund to benefit. The results from three European/UK REITs that either are or have previously been core positions within the Fund demonstrate the potential.

UK and European industrial landlord and developer SEGRO (LSE:SGRO) saw its portfolio valuation increase 0.9%, driven by rental growth of 5.3%. The portfolio valuation of European shopping centre landlord Klepierre (ENXTPA.LI) increased by 2% in the period, driven by rental growth of 6.0%. And Paris office landlord Gecina’s (ENXTPA:GFC) portfolio valuation rose 0.4%, again thanks to a rental increase of 6.3%.

The chart below also points to the potential of the region.

Change in yield across ~600 European real estate markets and sectors

Source: UBS, CBRE, DXAM

The evidence of fair value in direct transactions, M&A

Private markets often respond to value more quickly than public markets. Some recent transactions support the view that selected REITs currently offer good value.

Equity Residential (NYSE:EQR), for example, agreed to purchase 11 apartment complexes from Blackstone (NYSE:BX) for $964 million. This was the largest multifamily acquisition by a public REIT in the U.S. in seven years. The acquisition is part of a broader trend in the sector, driven by expectations of a rebound in rents and property values, partially due to the expectation of more interest rate cuts by the Federal Reserve.

Blackstone’s announced privatisation of Apartment Income REIT Corp. (NYSE:AIRC) at a 25% premium also reiterated the fundamental discount to fair value on offer across select residential portfolios. Pleasingly, investors in the Dexus Global REIT Fund benefited from our position in AIRC. These are only a few examples; we expect many more in the year ahead.

These are the key points for REIT investors and advisers to consider.

1. Solid operating fundamentals - Around the world, most commercial real estate sectors are experiencing firm operating fundamentals. Tenant demand is robust, and market rents are either stable or growing. 
2. Supply is severely constrained - While demand is holding up, supply is seriously constrained and likely to drop precipitously towards 2025. This is the delayed impact of an increased cost to build and higher  rates, which over the last few years have combined to hurt development feasibilities. This has constrained supply.
3. New developments have long lead times - This is a boon for incumbent owners. The scarcity of future supply within select sectors should benefit existing asset owners in the medium and longer term.
4.  Conditions are ripe for revenue growth - With annual rent growth often built into leases, the above factors also driving rental tension support further top-line revenue growth. This was one of the most encouraging features of the recent half-year reporting period across the global REIT universe but also especially evident domestically (see Four key takeaways from AREIT reporting season)
5.  Earnings and distribution growth should follow - As cost pressures subside and rental tension results in higher revenue, we expect higher bottom line earnings and distribution growth in the medium term. Private transaction data and global REITs deploying capital, either from surplus cash, equity raised from investors, or existing scrip as currency in the case of mergers and acquisitions, supports this view.

These points make a compelling argument. This is a period of transition and market re-calibration. It is also one of opportunity. History regularly shows that investments made at such points can be very rewarding. If you’d like to participate, learn more about the Dexus Global REIT Fund. 

Disclaimer

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