A REIT Rebound
The direction of U.S. monetary policy will be a crucial performance driver for real estate investment trusts (REITs) in 2024. The Federal Reserve’s decision in December to keep monetary policy unchanged, as well as a signal of three interest rate cuts this year, has brought music to the ears of REIT investors.
With projections indicating that the U.S. economy will skirt a recession (or at least a severe one), the REIT industry appears to be well-positioned for recovery. The Fed’s approach to combating inflation is anticipated to provide a boost to the sector, which relies heavily on the direction of interest rates.
The market’s pricing of six interest rate cuts in 2024 and the expectation of attractive dividend yields for REITs relative to fixed income and money-market yields reflects the potential for REITs to be an appealing income-generating investment in a lower-interest-rate environment.
Strength will continue in 2024, according to the REIT industry association Nareit. In its outlook for 2024 it said, “We are cautiously optimistic that despite those challenges, the REIT recovery could begin next year. The impressive performance of REITs during late October and November may be a signal that, as in previous periods of monetary policy adjustments, the end of the rate-rising cycle will herald a period of REIT outperformance.”
REITs have returned 20% over the next year after rates normalize, according to historical precedent, outperforming equities and private real estate. Nareit also expects the performance gap between public and private real estate to narrow throughout this time.
However, John Worth, Nareit’s executive VP of research and investor outreach, cautions that these returns will be uneven, implying that investors would be compensated for staying in the market rather than timing it.
Janus Henderson believes the public REIT market offers greater opportunities than the private real estate market. “In our view, public REITs’ access to capital and at relatively lower costs compared to private real estate sets them on the path for faster growth in the years ahead – an advantage that should not be underestimated,” said Guy Barnard, co-head of global property equities and portfolio manager.
In the public REIT market, where shares are already priced at or below more realistic values reflecting the new rate environment, recoveries typically begin six to nine months before direct values bottom, with excess pessimism removed as investors rebuild allocations to the sector; Barnard believes we are currently in this period.
“The combination of continued growth in the face of share price declines means public REIT shares have become much cheaper. In fact, since the beginning of 2022 while global REIT share prices have declined by more than 25%, REIT cash flows per share have grown by roughly 13%, resulting in an earnings multiple decline greater than any other equity sector,” added Barnard.
In 2023, publicly traded REITs were in a solid position in terms of portfolio metrics such as income growth and debt ratios, according to an outlook by Steve Buller and Sam Ward, real estate investment portfolio managers with Fidelity. However, alarming headlines about a commercial real estate crisis, fueled mostly by problems in the office sector, made investors wary of investing in REITs.
Cohen & Steers predicts that if the Fed can provide a soft landing for the U.S. economy this year, the sector will return 10% to 13%.
“While we believe a stabilization in interest rates is a crucial first step in real estate’s recovery, we also believe that a decline in rates is not a pre-requisite for public REITs to generate attractive returns from today’s levels because they are already trading at valuations that fully reflect the market’s concerns,” explained Barnard.
