March 22, 2024
By James Maydew
As inflation and interest rates stabilise, we believe real estate fundamentals are positioned to become the most important driver of opportunity and return.
- The steepest interest rate hiking cycle seen for 40 years has negatively impacted listed real estate valuations
- A stabilising of the rate and macro-economic environment would allow for a return to the fundamentals of listed real estate
- Long term growth in the asset class is underpinned by opportunity in key sectors of necessity real estate including healthcare and industrial sectors.
- The 2022-2023 interest rate hike cycle has been the steepest hiking cycle in 40 years. Over the course of this, the U.S listed real estate market, which represents around 65% of the global index, fell 44.6% from its peak at the start of the rate hike cycle in March 2022 through to the trough in October 2023.
Consequently the interest rate environment has dominated headlines and resulted in fundamentals largely taking a backseat. As we consider the outlook for listed real estate in 2024, we are able to leverage the research by our colleagues in Fixed Income and the views shared in their most recent Strategic Forum in January 2024 which suggest that:
- lower inflation remains a high conviction view for 2024
- growth is likely to remain low or stagnant with a risk of a mild recession
- the U.S Federal Reserve (the Fed) bringing inflation back closer to target would open the door for interest rate cuts in 2024
The question that remains for us: what would this mean for listed real estate?
How is listed real estate impacted by rising interest rates?
As the adage goes, interest rates are to asset prices, what gravity is to the apple. Typically, as rates rise, asset values decline, and as rates decline, asset values rise. This is particularly true for REITs, which by their nature look to capital markets to grow, and as a result typically carry some debt on balance sheet.
A decline in interest rates would have positive ramifications for listed real estate as a fall in both debt costs and the risk-free rate positively impacts valuations and would signify the potential end of what has been a brutal rate hiking cycle.
We believe that if there is a stabilising of the rate and macro-economic environment, this would represent an opportunity for listed real estate to revert to what we believe to be the most critical factor over the long-run, real estate fundamentals.
Are we at a turning point?
We have already seen a glimpse of a stabilising environment in December 2023, with U.S policymakers pencilling in no further interest rate rises for the first time since March 2021, and U.S REIT markets rallying 6.3% from announcement to the end of December.
Despite this, listed real estate still screens as cheap relative to both history and the S&P 500. Global listed real estate currently trades at a circa 11% discount1 to net asset values and a 0.6 multiple relative to the S&P 500. For historical context, as highlighted in Figure 1, this is comparable to the multiple differentials experienced during the GFC2.
Figure 1: REIT Relative Multiple vs S&P 500
Source: UBS 2024
The first leg of this rally has been driven by capital flows into the sector and fund manager positioning. The most recent Bank of America Fund Manager survey has shown that Fund Manager allocations into REITs was the largest single positive positioning change of major equity sectors with a +15% change in allocations, based on expectations that REITs will be amongst the best performers if the Fed initiates rate cuts over 20243.
Despite this, REITs remain a significant underweight relative to history and other major equity sectors. As highlighted in Figure 2, this has contributed to the sector underperforming the S&P 500 by circa 25% cumulatively over the last two years as rates rose. We believe the 23% rally that started in October 2023 has further room to run, as actual REIT allocations of general equity investors are still more than half the 2.3% weight in the S&P 500.
Figure 2: U.S REIT Index vs S&P 500 vs Nasdaq
Source: Bloomberg 2024
How has listed real estate recovered in the past?
US REITs historically have been up +30% on average (vs. S&P +20%) within 16 months of the last 4 Fed pauses. To put this into context, the recent Fed pause started on 26 July 2023, and REITs have returned +3.7% in 5 months (vs. +4.0% for S&P) given a notable sell off and a recovery rally during that time3.
This suggests to us that there is a catalyst underway for the REIT underweights to further unwind and that stabilising interest rates could bring fundamentals out of the shadows as a key driver of both opportunity and return.
History has supported this showing that an end to the rate hike cycle has been a positive catalyst for listed real estate with it outperforming both the S&P 500 and private real estate in the months following the end of a rate hike cycle.
What are the fundamentals telling us?
Fundamentals across most of our preferred sectors have remained resilient, and we expect net operating income for listed real estate sectors generally to achieve circa 5% p.a. growth from 2023-2027. Two examples which highlight this resilience include our exposures in key sectors including:
1. Healthcare: aging demographics globally has presented a significant opportunity for this sector: in the U.S, the number of adults aged 90 and over has tripled over the last three decades4. At the same time, there has been significant supply constraints with construction starts down 80% from peak levels.
This has underpinned the senior housing sector resulting in net absorption (the net difference in space that has become occupied compared to space that has gone vacant) of +129% vs the pre-pandemic average5. The sector is expected to experience earnings growth of circa 9.9% in 20256.
2. Industrial: the rise of e-commerce and a push for same day delivery has resulted in a sector that is currently experiencing one of the lowest vacancy rates in the sector for premium last-mile logistics facilities.
Supply continues to be constrained for these facilities in major metropolitan markets as land is simply not available. The sector is expected to experience earnings growth of circa 14.6% in 20256.
Source: Goodman
Investment implications
We believe that, if the end of the rate hike cycle is near, this brings opportunities for listed real estate fundamentals to take centre stage and offers opportunities for investors to take advantage of a dislocation in markets and allocate to what we consider to be fundamentally well supported real estate securities.
We remain optimistic for the asset class and continue to be positioned in what we believe are the highest quality listed real estate securities globally across sectors such as senior housing, industrial, cold storage, healthcare, single family residential, manufactured homes, data centres and telecommunication towers.
1 UBS Discounts to NAV as at February 2024
2 UBS 2024 REIT Outlook – 31 January 2024. Using US REITs as a proxy for GLRE as they account for c65% of Global benchmarks
3 Source: Macquarie Asset Management, Bank of America Fund Survey January 2024, Green Street Advisors, Bloomberg, Morgan Stanley, Welltower 2023.
4 United States Census
5 Welltower 2023
6 Visible Alpha 2024
IMPORTANT RISK CONSIDERATIONS
Investing involves risk, including the possible loss of principal.
The views expressed represent the investment team’s assessment as of the date indicated and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice.
Past performance does not guarantee future results.
Macquarie Asset Management (MAM) is the asset management division of Macquarie Group. MAM is an integrated asset manager across public and private markets offering a diverse range of capabilities, including real assets, real estate, credit, equities and multi-asset solutions. The public markets businesses are a part of MAM and includes the following investment advisers: Macquarie Investment Management Business Trust (MIMBT), Macquarie Funds Management Hong Kong Limited, Macquarie Investment Management Austria Kapitalanlage AG, Macquarie Investment Management Global Limited, Macquarie Investment Management Europe Limited, and Macquarie Investment Management Europe S.A.
Macquarie Asset Management is part of Macquarie Group, a diversified financial group providing clients with asset management, finance, banking, advisory, and risk and capital solutions across debt, equity and commodities. Founded in 1969, Macquarie Group employs approximately 21,000+ in 34 markets and is listed on the Australian Securities Exchange.
Other than Macquarie Bank Limited (MBL), none of the entities noted in this document are authorised deposit-taking institutions for the purposes of the Banking Act 1959 (Commonwealth of Australia). The obligations of these entities do not represent deposits or other liabilities of MBL. MBL does not guarantee or otherwise provide assurance in respect of the obligations of these entities, unless noted otherwise.
All figures as at 30 September 2023.
(3523789 – 04/24)
