The July edition of our Real Estate Securities Investment Guide is now live!
Learn more on the effects of real interest rates on REIT performances and just how they can be used as an investment
Our market specialists bring you the most up-to-date market information monthly on real estate securities* – frequently referred to as REITs (Real Estate Investment Trusts). Every month our Head of Real Estate Strategy, Pol Tansens, shares key information to help investors stay abreast of the many global market evolutions.
June was a difficult month for REIT investors, just like May. All markets ended in negative territory, with Japan losing most (-4.8%). Moreover, the returns carried by common shares performed better than REIT performances (with the exception of the U.K.), reflecting the sensitivity of REITs to the prospects of higher real interest rates.
REITs are liquid property investments. And although liquidity has a positive connotation in the investment world, it also has a negative one since it comes with certain consequences. Indeed, listed property can be easily sold, and this is exactly what is happening today due to higher real interest rates that are pushing investors with a short-term investment horizon to sell. Additionally, higher real rates may have a temporary negative impact on REITs because: 1) the cost of borrowing may rise (especially if part of the REIT debt is contracted at floating rates), 2) other investment opportunities may reappear on the investors’ radar (investment-grade bonds for instance) and 3) gross initial yields (capitalization rates) of the underlying properties could also soar, with investors asking for higher risk premiums. Higher cap rates may lead to lower values, triggering net asset values of REITs down eventually.
We believe long-term investors should not worry too much today. Much will depend on the health of the overall economy in the mid-future; and irrespective of the outcome, REIT investors may still gain eventually. Either core inflation will gradually come back in the more economically mature parts of the word (Europe, the U.S., mature Asia) as a result of the economy’s recovery process, leading to higher (indexed) rents, and thus higher values. As said in our May edition, inflation would not necessarily lead to higher real rates. Or, nominal interest rates will start edging lower again for whatever reason, which would widen the spreads (+200bp) between dividend yields and risk-free long-term sovereign bonds. Consequently, REITs would once again be considered as a very attractive income play.
That’s why we recommend long-term investors (with a horizon of over 5 years) to regularly add high-quality REITs to their portfolios at a time when short-term investors sell their shares. Obviously, investors should only buy REITs which own high-quality prime assets that are well let with high security of rental income, thus having strong balance sheets and reasonable LTVs. For example, the overall LTV for European REITs stands at 38.7% for Europe. Furthermore, gross dividend yields vary from 3% for European and Asian REITs to roughly 4% for North America REITs (source: EPRA, June 2015).
* Real estate securities provide investors a liquid way to access property assets without having to buy property directly. A real estate securities is a share of a company or trust, privately held or listed, that manages a portfolio of income-producing properties, such as shopping malls, office buildings, apartments...