Part 2: Global REITs - The most attractive sub-sectors

This is part 2 in the Global REITs series. Click here to read ‘Part 1: Global REITs - As the cycle turns, opportunities abound’ and ‘Part 3: When offence is the best defence: Capitalising on the Global REIT Transition’.

It’s impossible to embark on a review of any investment class or sector without a process for doing so. In managing the Dexus Global REIT Fund, we look at investment opportunities from two perspectives.

First, we undertake a deep analysis of a REIT’s underlying portfolios. This is done on an asset-specific basis with a focus on the most important drivers of investment returns-property type and location. Then we scrutinise a REIT’s corporate and capital structure, with particular attention paid to balance sheet resilience and management capability.

This bottom-up approach is followed by a top-down overlay, where we ascribe risk ratings across property types and market geographies. Both perspectives are considered as part of a highly-developed process developed over many years by our experienced investment team.

The aim is to find opportunities where local supply and demand dynamics underpinning a REIT’s portfolio offer the best prospects for rental tension. This, we have found, is the best way to deliver attractive earnings growth and total returns over time, provided the capital structure and corporate wrapper are sound.

Our thoughts on the major Global REIT sub-sectors resulting from this approach are outlined below:

Industrial

Demand for industrial properties exploded during the pandemic and, although growth rates have slowed, remains robust. Reshoring, e-commerce growth and supply chain resilience has made fulfilment a key battleground for logistics operators and retailers, driving demand for space offering the most efficient first and last-mile operations.

From 2019 to 2023, rents in major urban gateway markets like Southern California and Sydney ran hard as tenants expanded ahead of anticipated capacity. The focus now is on optimising existing logistics hubs, with transportation the largest cost component for most tenants. Locations close to key rail, port and highway infrastructure are key to doing so, not to mention the end consumer.

Other factors are at play. In healthcare logistics, for example, the market is currently valued at $130bn. By 2026, driven by global ageing and a need for reliable delivery of pharmaceuticals, it is expected to be worth $152bn.

Examples like this mean Industrial REITs should have among the highest earnings growth across the various sub-sectors as rents on expiring leases revert to higher market rents in the coming periods.

The only negative considerations are potential excess supply or tenant utilisation changes due to slowing GDP growth or a much-forecast-but-yet-to-arrive recession.

Retail

Tenants lost to pandemic bankruptcies have been replaced by new occupants at higher rents and supply remains low with no signs of ramping up. Both these factors bode well for attractive rental, bottom line earnings and ultimately, total return growth.

We have the highest conviction in quality daily-needs focused Strip Retail REITs that dominate their local catchments. These are must-have location for retailers where demand is increasing but the supply response is negligible. Landlords are very well placed, as the following chart suggests.

U.S. Strip Retail Supply Growth (YoY)

 Source: Green Street Advisers

Elsewhere, the shift to working from home has led shoppers to favour open air and mixed-use centres, while local lifestyle centres are gaining in popularity, especially among the young. With e-commerce struggling to change consumer habits in this area, grocery-anchored retailing also has an edge.

In summary, the current investment environment favours retail landlords in high quality locations with little available space, tenants continuing to expand and no significant supply growth.

Healthcare

The developed world’s aging population offers the prospect of a multi-year demographic dividend, some of which will be paid by tenants of healthcare landlords. This shift is particularly pronounced in Canada where seniors’ housing supply needs to double in the next two decades to meet forecast demand.

Covid hit senior housing hard as occupancy rates fell below 80%, but the recovery is under way. Select REIT portfolios, particularly in North America, expect occupancy to revert to pre-pandemic levels of around 95% by the end of 2025.

This would add materially to the bottom line, especially given new supply in this sub-sector has also been constrained. We expect this to drive double-digit earnings growth int the near term.

New Seniors Housing Construction starts as a % of Inventory (Canada)

Source: Chartwell Retirement Housing, Cushman & Wakefield

Residential

Residential REITs are generally a deep and diverse sub-sector in all major developed markets except Australia. In the U.S. (the largest for-rent residential REIT market globally), chronic under-supply and, more recently, higher mortgage rates and a lack of affordability in the owner occupier market (see chart below) are driving rental demand.

There are four key sub-components to global residential REITs—single-family (detached housing), multi-family (apartments), Manufactured Housing Estates (land-lease communities—MHE) and purpose-built student accommodation (PBSA).

We favour select U.S.-based MHE landlords. These offer highly affordable middle-market rental products, particularly to retirees and those over the age of 55. The demographic tailwind is attractive to investors and rents per square foot can be half that of multi-family and single family rentals. Millennials also view them as an affordable opportunity to enter the market.

Again, the acute supply constraint in affordable housing is at play. Manufactured housing developments have dwindled over the last 20 years due to zoning restrictions and regulations.

Share of U.S. home listings considered affordable on the median income

Source: Redfin

Technology

The fourth industrial revolution, driven by data, is well underway and the advent of widespread artificial intelligence (AI) is accelerating its pace. This is providing REIT investors with some fantastic opportunities.

Data Centre REITs are our preferred technology exposure, with hyperscale users like Amazon, Microsoft and Google aggressively investing in capacity (see chart below). A data centre REIT investment is a “pick and shovel” approach to the sector, as opposed to an investment in the ultimate technology application or developer.

As ever, geography matters. Data centres (DCs) in Singapore, for example, benefit from one of the most power constrained and expensive markets for DCs worldwide. Capacity is hard to secure as the city-state has restrained land for Data Centre development, while its secure location as a pan-Asian sub-sea cable hub makes it vitally important. Access to power capacity in those markets where it is limited, will be a differentiating factor and, in our view drive long-term investor returns.

Hyperscaler Capex Investment Accelerating

Source: Jefferies

Whilst the valuations are attractive and the opportunities numerous, careful assessment of select Global REIT investment opportunities will be crucial. This is where the Dexus Global REIT Fund’s process and approach can help. To find out more, please get in touch with a member of our team.

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