LaSalle: 2025 could be the new “golden era” for REITs
Matt Sgrizzi, Chief Investment Officer, LaSalle Global Solutions and Securities Global Portfolio Manager
A version of this article was first published on Financial Express, 2 December 2024 issue.
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The last two and half years have been a rough ride for listed real estate investment trusts (REITs). Driven by the rapid tightening of financial conditions, sentiment towards REITs has been weighed down not only by the higher interest rate environment, but also by constrained bank lending, a barrage of negative headlines about commercial real estate, and REIT underperformance relative to the broader equity market. But, as the saying goes, it’s often darkest before the dawn.
The modern REIT period has seen three “golden eras” of REIT investing, which have been characterised by either a dramatic growth in the REIT market or outsized investment returns versus other asset classes, or both. And we are starting to see signs of the fourth ‘golden’ era emerge.
Previous ‘Golden’ eras
As the graph below shows, the first ‘golden’ era of REIT investing followed the Savings and Loan (S&L) crisis in the mid-1990s. During this period, the number of REITs increased by nearly 50 per cent, while the market cap of that group grew nearly seven-fold.
The second was post dot-com bubble where the REIT market cumulatively outperformed broader equity markets by more than 300 per cent.
After the Global Financial Crisis (GFC) there was a significant rise of dynamic new property sectors in the public market, and another period of outperformance in which REITs led broader equities by 50 per cent.
Source: LaSalle Research
Each golden era was unique, however our analysis has found that each era is preceded by a challenging environment with four common elements: a dislocation of bank lending to real estate; broad-based negative sentiment around real estate; underperformance versus broader equities; and an easing or reset of financial conditions.
Today, the post-pandemic recovery and the Great Tightening Cycle (GTC) that followed presents similarities to these elements mentioned above. At the moment, real estate bank lending is dislocated, the AI-driven tech frenzy and fears of a generalized “commercial” real estate malaise mean REITs have underperformed compared to equities, and signs of an easing or stabilization in financial conditions and a global monetary easing cycle are becoming more apparent.
While history does not repeat itself, it does often rhyme. So what are the signs that the ‘golden’ era may be just around the corner?
Challenged real estate lending
The past two to three years have been characterized by a significant retrenchment in bank lending to real estate. According to the US Senior Loan Officer Survey, the net balance between demand for loans and banks’ willingness to lend points to the widest undersupply of credit in the past ten years, except for during the depths of COVID-19. The shortage is evident in all styles of borrowing, from riskier construction loans to mortgages backed by traditional, defensive apartment assets.
This circumstance presents an opportunity for REITs given their strong financial positions and access to the capital markets. Having learned a painful lesson from the GFC, global REITs went into the GTC 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. Looking specifically at the US market, the overwhelming majority of REIT borrowing – nearly 80 per cent – is from the unsecured market, at rates that are today almost 100 basis points lower than a traditional mortgage. This relative advantage in both access and cost of capital positions REITs to potentially play the role of aggregator and to take market share.
Underperformance may set the stage for a return to outperformance
The negativity around lending or financing concerns and the “death of office” have weighed on both the absolute and relative performance of REITs. The chart below shows the rolling one-year relative performance differential between REITs and equities; it indicates that REIT underperformance has reached its typical peak historical level before starting to reverse. Periods of underperformance have historically tended to reverse and this instance is no different with the performance gap already narrowing.
There is more to “commercial” real estate than office
Headlines proclaiming the demise of commercial real estate usually involve a misleading generalisation, as REITs is more than just office. In reality, office has become a smaller portion of the real estate landscape, especially in the public market where office is only about 6 per cent of global REITs by market capitalization. REITs is much more diverse and includes industrial and logistics, forms of rental residential, manufactured housing and student housing, various formats of healthcare property, and exposure to tech-related real estate in the form of data centres and cell towers. Many of these sectors have earnings growth forecasts that are in line with or better than broader equities, which is underpinned by a combination of secular demand drivers and declining supply levels.
The start of a global monetary easing cycle
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. 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.
When can we expect the next ‘golden’ era?
Over the past 25 years, REITs have produced total returns of 8 per cent per annum, with 4-5 percentage points of that return coming from income. Given today’s fundamental outlook and interest rate levels, we expect the base case for the REIT market for the next three years to produce total returns of 9 per cent, with roughly four percentage points of that coming from income.
If financial conditions ease further, such as by 50 basis points or 100 basis points, we expect those return expectations to increase to 13 per cent and 18 per cent, per annum, respectively, setting the stage for the next “golden era” in REITs.
Related products:
SGH LaSalle Concentraded Global Property Fund
SGH LaSalle Global Listed Property Securities Fund
SG Hiscock & Company has prepared this article for general information purposes only. Any advice that may have been given is general only and has been prepared without taking into account readers’ objectives, financial situations or needs. Readers should consider the appropriateness of the advice in light of their own objectives, financial situations or needs before acting on the advice.
