Todd Kellenberger
Client Portfolio Manager, Real Estate Securities
Principal’s real estate team has gone through many cycles in the past 25 years of REIT investing. The story of this recent cycle, which I mark as the start of 2022 when the REIT market peaked and the US Fed started to hike rates, has been about inflation and rising interest rates. What’s been surprising is the sustained US economic expansion despite these headwinds, a positive tailwind for REIT earnings in recent years.
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We believe an increase in activity is likely in 2025. Sellers will potentially come off the sidelines as private equity valuations reach a floor and debt maturities rise. Recent improvement in the cost of capital and overall capital availability for REITs puts them in a strong position to capitalise on these opportunities.
With public market access and generally low-leverage balance sheets, REITs have an advantage. We saw REITs increase their activity this past year and continue to build up their liquidity. This will likely accelerate their external growth prospects.
The green light for REITs to be more aggressive is where they have a strong cost-of-capital advantage versus current market values — in other words, trade at a premium to price to NAV — and attractive uses for the capital. For example, US healthcare, shopping centres, and data centres are sectors where we think REITs will likely remain on the offensive. Industrial REITs, on the other hand, may be on the sidelines for a bit longer until stock prices recover and cost of capital improves. In office, there will probably be some increase in activity with select REITs, but in general, there is still investor caution for the office sector overall.
The presidential election and changing US administration has created a bit more uncertainty in terms of our outlook for interest rates in the year ahead. The path for REITs can be a favourable one if inflation remains under control and President Trump’s policies do not reignite it. But if a sustained second wave of inflation materialises, interest rates and real estate cap rates will potentially rise given tight spreads. Possible tailwinds would likely come from any pro-growth initiatives the new administration could enact. A strong economy isn’t a bad thing for real estate. If a strong economy is sustained, and the policies are not overly inflationary, that could create a favourable set-up for the REIT market in 2025.
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