Interest-rate outlook brightens potential for REITs

The rise in interest rates over the past two years has had a significant impact on real estate around the globe. However, compelling opportunities are now may seems appearing within real-estate investment trusts (REITs). Given potentially attractive valuations and the scope for interest-rate cuts, these may offer Asia-based investors the ability to target key structural trends worldwide.

Ready for take-off?

In 2023, investing in the real-estate investment trust (REIT) market proved challenging, given the economic environment. However, a peak in long-term real yields has historically provided a catalyst for REITs to outperform. Consequently, 2024 could potentially prove a much better year for global REIT investors.

REITs market in 2024?

Slowing economic growth and moderating inflation may usher in a favorable environment for public real-estate stocks as investors seek more defensive and durable cash flows in choppier economic conditions.

The prospect of peaking and potentially declining interest rates may also increases the appeal of the relatively high dividend yields generated by REITs when compared with lower-risk fixed income securities. Central bank rate cuts could directly reduce REIT borrowing costs, feeding through to higher dividends possibility.

The past two years have seen a significant correction in the valuation of real-estate stocks after a prolonged period of rising yields. Arguably, REITs have priced in a higher-for-longer yield environment for 2024 and are looking fairly cheap compared to public equities and private real estate. Consequently, investors may have the opportunity to access, relative to both public equities and private real estate, a deeply discounted listed real-estate market.

Capturing the potential of secular growth drivers

As the economic tide turns, some of the most interesting opportunities among REITs are those properties that benefit from structural demand drivers offering potentially resilient, visible, and predictable cash flows. For example, there is a demographic story playing out in the U.S. as a critical mass of people approach 80 years old, boosting demand for senior housing facilities.

Wireless-tower REITs market may provide another opportunity. Long-term growth in mobile data usage, edge computing, and the continued build out of the wireless tower network may bring visibility and predictability to cash flows. Wireless-tower REITs have fallen out of favor in recent years due to their sensitivity to interest rates. However, as the headwind of higher rates recedes, there is potential for these companies may outperform going forward.

Locally in Asia, Japanese property stocks—particularly those companies that invest and build commercial properties could be an area of focus. Unlike U.S. office REITs, which face well-documented challenges, Japanese commercial properties may enable investors to participate in the Japanese reflation trade and may benefit from the improving corporate governance theme.

Finally, U.S. single-family rental REITs market may provide an interesting opportunity. These properties may benefit from the large gap in home affordability compared with renting. In many U.S. markets, the all-in cost of home ownership, with high mortgage rates and high home prices may make it an appealing time to rent rather than buy. With many first-time home buyers opting for home rentals, the single-family rental REIT market is likely poised to outperform.

Capturing the AI theme with REITs

Data centers are critical components supporting our growing dependence on technology and may offer investors a way to participate in the rapidly growing artificial intelligence (AI) theme. Surging demand, coupled with high barriers to entry for new supply, amid a global search for attractive investment opportunities, may have thrust the sector center stage.

Data-center REITs, with growth and defensive attributes, are relatively resilient to both economic downturns and periods of economic expansion. They tend to be less correlated with other asset type which may help enhance diversification benefits. Especially for the longer leases with more than 10 years, they may increase the exposure to cash flows from high-quality credit tenants at relatively attractive yields than other property types.

Flight to quality in the office sector

Office space is attracting adverse headlines due to the work-from-home trend, which is affecting demand. However, offices may still hold potential for discerning investors. When people do head into work, they are looking for welcoming, well-located environments with good amenities. Meanwhile, landlords and tenants are looking for buildings with excellent environmental qualities.

Combined, these trends may mean the very best offices can demand rental premiums. Attractive investment opportunities may be areas such as central Paris, which is benefiting from an exodus from La Défense, a huge, purpose-built business district three kilometers west of the city limits. Similarly, in the U.K., companies are relocating from Canary Wharf to the West End. Asia is less impacted by the work-from-home trend given the work culture which emphasizes face time, shorter commuting distances, and smaller homes (usually apartments). Consequently, there are multiple interesting ways to play the fight to quality theme in Asia.

Global REITs offer Asia-based investors access to a global real estate opportunity set that may have attractive valuations and may be benefiting from long-term structural trends. Combined with the potential for portfolio diversification, and a compelling macro-economic landscape, global REITs may become increasingly attractive as central banks start to ease monetary policy, may allow investors to retain a meaningful exposure to the manifold attractive investment opportunities within the region.