The conditions for real estate investment trusts (REIT) to play a greater role in generating returns have turned, with a potential new golden era likely to commence in the next year, a global sector securities investment manager has predicted.
LaSalle Investment Management Securities chief investment officer and portfolio manager Matthew Sgrizzi said there were identifiable patterns that helped predict changes in market conditions and an examination of historical under and overperformance for listed REITs found there were four common factors that drove returns.
Those elements are an undersupply of bank lending to real estate, negative sentiment around real estate, underperformance of REITs against broader share markets and an easing or reset of financial conditions, and these were present in the market.
“The current environment resembles the set-up for these historical golden eras, suggesting REITs may be on the cusp of its next golden era of investment,” Sgrizzi said.
“Many of the factors supporting the REIT market’s upbeat prospects are also positives for real estate as a whole. For example, an easing in financial conditions has historically been a driver of strong forward REIT returns, as well as those for private equity real estate.”
He pointed out bank lending to real estate had fallen away to its lowest point in the past 10 years, outside the COVID-19 downturn, but this was an opportunity for REITs, which had maintained strong financial positions.
“Global REITs entered the recent tightening cycle with their lowest leverage levels on record and nearly 90 per cent of their debt on fixed rates and an average remaining term of seven years,” he added.
He pointed out the underperformance of REITs relative to broader equities had reached the typical peak historical levels that come before a reversal and the current global monetary easing cycle would add further positive momentum.
“Real estate is a capital-intensive business that is sensitive to changes in financial conditions, an observation that holds true for both directions of interest rate change,” he noted.
“The downside of this was evident in 2022 and 2023, but the upside is likely coming into play. A global monetary easing cycle is now underway, with several central banks cutting rates. Historically, REITs perform well in periods leading up to and following a central bank easing cycle.”
He projected REITs were likely to produce total returns of 8 per cent to 9 per cent a year, in line with historical averages over the past 25 years, with around four percentage points of that return coming from income.
“If financial conditions were to ease further, these return expectations could increase to the mid-to-high-teens range per annum, which aligns with previous golden-era REIT performance,” he said.
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