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.
Source: Goodman
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 double digit earnings growth in 20256.
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.
Authors
1UBS Discounts to NAV as at February 2024
2UBS 2024 REIT Outlook – 31 January 2024. Using US REITs as a proxy for GLRE as they account for c65% of Global benchmarks
3Source: Macquarie Asset Management, Bank of America Fund Survey January 2024, Green Street Advisors, Bloomberg, Morgan Stanley, Welltower 2023.
4United States Census
5Welltower 2023
6Visible Alpha 2024
Related products
Important information
The opinions expressed are those of the author(s) are as of the date indicated and may change based on market and other conditions. The accuracy of the content and its relevance to your client’s particular circumstances is not guaranteed.
This market commentary has been prepared for general informational purposes by the team, who are part of Macquarie Asset Management (MAM), the asset management business of Macquarie Group (Macquarie), and is not a product of the Macquarie Research Department. This market commentary reflects the views of the team and statements in it may differ from the views of others in MAM or of other Macquarie divisions or groups, including Macquarie Research. This market commentary has not been prepared to comply with requirements designed to promote the independence of investment research and is accordingly not subject to any prohibition on dealing ahead of the dissemination of investment research.
Nothing in this market commentary shall be construed as a solicitation to buy or sell any security or other product, or to engage in or refrain from engaging in any transaction. Macquarie conducts a global full-service, integrated investment banking, asset management, and brokerage business. Macquarie may do, and seek to do, business with any of the companies covered in this market commentary. Macquarie has investment banking and other business relationships with a significant number of companies, which may include companies that are discussed in this commentary, and may have positions in financial instruments or other financial interests in the subject matter of this market commentary. As a result, investors should be aware that Macquarie may have a conflict of interest that could affect the objectivity of this market commentary. In preparing this market commentary, we did not take into account the investment objectives, financial situation, or needs of any particular client. You should not make an investment decision on the basis of this market commentary. Before making an investment decision you need to consider, with or without the assistance of an adviser, whether the investment is appropriate in light of your particular investment needs, objectives, and financial circumstances.
Macquarie salespeople, traders and other professionals may provide oral or written market commentary, analysis, trading strategies or research products to Macquarie’s clients that reflect opinions which are different from or contrary to the opinions expressed in this market commentary. Macquarie’s asset management business (including MAM), principal trading desks and investing businesses may make investment decisions that are inconsistent with the views expressed in this commentary. There are risks involved in investing. The price of securities and other financial products can and does fluctuate, and an individual security or financial product may even become valueless. International investors are reminded of the additional risks inherent in international investments, such as currency fluctuations and international or local financial, market, economic, tax, or regulatory conditions, which may adversely affect the value of the investment. This market commentary is based on information obtained from sources believed to be reliable, but we do not make any representation or warranty that it is accurate, complete, or up to date. We accept no obligation to correct or update the information or opinions in this market commentary.
Opinions, information, and data in this market commentary are as of the date indicated on the cover and subject to change without notice. No member of the Macquarie Group accepts any liability whatsoever for any direct, indirect, consequential, or other loss arising from any use of this market commentary and/or further communication in relation to this market commentary. Some of the data in this market commentary may be sourced from information and materials published by government or industry bodies or agencies, however this market commentary is neither endorsed or certified by any such bodies or agencies. This market commentary does not constitute legal, tax accounting, or investment advice. Recipients should independently evaluate any specific investment in consultation with their legal, tax, accounting, and investment advisors.
Past performance is not indicative of future results.
This market commentary may include forward-looking statements, forecasts, estimates, projections, opinions, and investment theses, which may be identified by the use of terminology such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “may,” “can,” “plan,” “will,” “would,” “should,” “seek,” “project,” “continue,” “target,” and similar expressions. No representation is made or will be made that any forward-looking statements will be achieved or will prove to be correct or that any assumptions on which such statements may be based are reasonable. A number of factors could cause actual future results and operations to vary materially and adversely from the forward-looking statements. Qualitative statements regarding political, regulatory, market, and economic environments and opportunities are based on the author’s opinion, belief, and judgment.
Past performance does not predict future returns.
Diversification may not protect against market risk.
Natural or environmental disasters, such as earthquakes, fires, floods, hurricanes, tsunamis, and other severe weather-related phenomena generally, and widespread disease, including pandemics and epidemics, have been and can be highly disruptive to economies and markets, adversely impacting individual companies, sectors, industries, markets, currencies, interest and inflation rates, credit ratings, investor sentiment, and other factors affecting the value of the Strategy’s investments. Given the increasing interdependence among global economies and markets, conditions in one country, market, or region are increasingly likely to adversely affect markets, issuers, and/or foreign exchange rates in other countries. These disruptions could prevent the Strategy from executing advantageous investment decisions in a timely manner and could negatively impact the Strategy’s ability to achieve its investment objective. Any such event(s) could have a significant adverse impact on the value and risk profile of the Strategy.
Investing in the real estate industry includes risks such as declines in real estate value, lack of availability of mortgage funds, overbuilding, extended vacancies, increases in property taxes, changes in zoning laws, costs from cleanup of environmental problems, uninsured damages, variations in rents, and changes in interest rates.
REIT investments are subject to many of the risks associated with direct real estate ownership, including changes in economic conditions, credit risk, and interest rate fluctuations.
Inflation is the rate at which the general level of prices for goods and services is rising, and, subsequently, purchasing power is falling. Central banks attempt to stop severe inflation, along with severe deflation, in an attempt to keep the excessive growth of prices to a minimum.
Leverage refers to the risk associated with securities or practices (for example, borrowing and the use of certain derivatives) and investment in certain types of derivatives that multiply small index or market movements into larger changes in value. Use of derivative instruments may involve leverage. Leverage magnifies the potential for gain and the risk of loss. As a result, a relatively small decline in the value of the underlying investments could result in a relatively large loss. Although the Fund will seek to manage the Fund’s risk from the leverage associated with derivative investments by closely monitoring the volatility of such investments, the Fund may not be successful in this respect.
Liquidity risk is the possibility that securities cannot be readily sold within seven days at approximately the price at which a fund has valued them.
Quantitative tightening (QT) refers to when central banks raise the federal funds rate. In a tightening monetary policy environment, a reduction in the money supply is a factor that can significantly help to slow or keep the domestic currency from inflation.
A sector is a segment of the economy that includes companies providing the same types of products or services. Although companies within a sector tend to be reasonably consistent in their fundamentals, these fundamentals may differ substantially from one sector to another. For example, some sectors are cyclical, rising and falling with changes in the economy while others are defensive, maintaining their strength despite economic ups and downs.
Macquarie Group, its employees and officers may act in different, potentially conflicting, roles in providing the financial services referred to in this document. The Macquarie Group entities may from time to time act as trustee, administrator, registrar, custodian, investment manager or investment advisor, representative or otherwise for a product or may be otherwise involved in or with, other products and clients which have similar investment objectives to those of the products described herein. Due to the conflicting nature of these roles, the interests of Macquarie Group may from time to time be inconsistent with the interests of investors. Macquarie Group entities may receive remuneration as a result of acting in these roles. Macquarie Group has conflict of interest policies which aim to manage conflicts of interest.
All third-party marks cited are the property of their respective owners.
Macquarie Asset Management (MAM) operates through entities including: Macquarie Investment Management Business Trust, Macquarie Funds Management Hong Kong Limited, Macquarie Investment Management Austria Kapitalanlage AG, Macquarie Asset Management Japan Co., Ltd., Macquarie Investment Management Australia Limited, Macquarie Investment Management Global Limited, Macquarie Investment Management Europe Limited, and Macquarie Investment Management Europe S.A.
The views expressed above represent those of the relevant investment team and are subject to change. No information set out above constitutes advice, an advertisement, an invitation, a confirmation, an offer or a solicitation, to buy or sell any security or other financial product or to engage in any investment activity, or an offer of any banking or financial service. Some products and/or services mentioned on this website may not be suitable for you and may not be available in all jurisdictions.
Investing involves risk including the possible loss of principal. The investment capabilities described herein involve risks due, among other things, to the nature of the underlying investments. All examples herein are for illustrative purposes only and there can be no assurance that any particular investment objective will be realized or any investment strategy seeking to achieve such objective will be successful. Past performance is not a reliable indication of future performance.
Before acting on any information, you should consider the appropriateness of it having regard to your particular objectives, financial situation and needs and seek advice.
Other than Macquarie Bank Limited ABN 46 008 583 542 (“Macquarie Bank”), any Macquarie Group entity noted in this document is not an authorized deposit-taking institution for the purposes of the Banking Act 1959 (Commonwealth of Australia). The obligations of these other Macquarie Group entities do not represent deposits or other liabilities of Macquarie Bank. Macquarie Bank does not guarantee or otherwise provide assurance in respect of the obligations of these other Macquarie Group entities. In addition, if this document relates to an investment, (a) the investor is subject to investment risk including possible delays in repayment and loss of income and principal invested and (b) none of Macquarie Bank or any other Macquarie Group entity guarantees any particular rate of return on or the performance of the investment, nor do they guarantee repayment of capital in respect of the investment.
Additional important information (including regional disclosures)
© 2024 Macquarie Group Limited