Is now the ‘REIT’ time to invest? The Long and Short of it

REITs – Real Estate Investment Trusts – represent a slightly alternative form of liquid investment to traditional stocks and shares, with between 90 to 100% of their taxable income redistributed in the form of dividends to investors. They are identified by strong, investment-grade balance sheets with conservative leverage metrics and moderate risk implications. Between 1990 and 2010, according to the FTSE NAREIT Equity REIT Index, the index’s average return was second to only mid-cap stocks, at 9.9%, above fixed income assets at 7% annual returns. In recent years, REITs have boasted an average annual return of 11.26%. There are two principle forms of REITs: Equity REITs (the most common), which generate sustained passive income through rent collection and sales of property, and Mortgage REITS (mREITs) which provide financing through the origination of mortgages and mortgage-backed securities associated with the commercial property sector. Hence, whilst some REITs tend to focus upon a specific industry, most have a diversified portfolio.

However, following reports from XLRE, the Real Estate Select Sector SPDR, they have underperformed immensely this year; providing a total return of -8%, and despite modest gains of 1.3% in the third quarter of this year, the S&P 500 continues to outpace returns of REITs with gains of around 8.9%. Moreover, critics highlight their inadequacy during the global financial crisis, as they failed to protect or behave as an anchor for established portfolios when other asset classes were struggling. Does the COVID-19 recession therefore pose a similar predicament? Whilst on the forefront of it, many would argue that the current burgeoning real estate prices surely indicate that we are on the verge of another collapse, in reality, the housing market is in a much more economically sound position today, as REIT leverage is more conservative following the imposition of stricter banking regulation, with debt at around 31% of asset value today compared with 46% in 2007.

Therefore, this current poor performance bestows a very unique opportunity upon strategic investors. In many cases at the moment, Premiums to Net Asset Value (NAV) have transformed into Discounts; effectively you can now purchase real estate for 50 pence to the pound. Yields have doubled in size, from 3-4% to 6-8%, and valuation metrics such as Funds from Operations (FFO) have halved to 10x from 20x. As lockdown restrictions are eased and the market reopens, it seems probable that valuations will return closer to their previous NAV, complemented by the fact that earnings estimates of many REITs have also been revised upwards. This is illustrative of strong fundamentals for most property types across developed markets whilst equity earnings projections have been trimmed, giving listed properties a slight edge.

Both Healthcare and Industrial REITs represent some of the most attractive sectors. Healthcare REITs invest in medical centres, hospitals, nursing facilities and retirement homes. Whilst market conditions do remain soft and slow, a pandemic will not curb the demographic shift, consequential of the 1950/60’s baby boom, and according to Age UK, almost 22% of the UK population will be over the age of 65 by 2030. Alongside COVID-19, which affirmed the pre-eminence of a well-funded, adequate and efficient healthcare system within society, healthcare institutions are backed by public funding and hence are unlikely to default, representing a relatively safe and stable investment.

Another form of REIT that has perhaps benefitted from the pandemic-induced e-commerce boom are Industrial REITs, which own logistics centres and delivered a positive total divisional return of 11.5% through the first eight months of this year. Logistics centres are responsible for the shipment of goods purchased on the internet; the sharp rise in demand for e-retail, with global annual sales of around 4.13tn (USD), and movement away from traditional shopping methods following the pandemic-induced social distancing rules, signifies the likely longstanding success of Industrial REITs. The share price for Equinix Inc. for example who dominate the data centre space has slowly risen

through the pandemic, up 48.5% from January 2020, demonstrating the importance of Industrial REITs in accommodating changing business environments.

The immediate outlook of these investment trusts may not be as glamorous as one may have hoped, however, they certainly represent an attractive opportunity for long term investment strategists. The evidence that newly built property prices remain below long term trends in conjunction with favourable capital-market conditions of low interest rates and inflation are creating an environment where REITs that have been able to strengthen their balance sheets since the crisis can issue equity to finance new acquisitions – keeping their balance-sheet leverage in control and credit quality in good shape as they add income-producing assets to their earnings base. These strong economic fundamentals dovetailed with general accelerating rental income growth certainly validate some investment consideration.

Analyst: Tristan May

Sector Head: Theo Thomas

Editor: Harry Forbes-Nixon

Leave a Comment