Looking to invest in REITs? “Revert to the basics.”

Looking for the most up-to-date market information on real estate securities*, also known as REITs (Real Estate Investment Trusts)? Every month, our Head of Real Estate Strategy, Pol Tansens brings you key information enabling you to stay abreast of this rapidly evolving global market.

May was not a very good month for REIT investors. All markets, except the U.K, ended in negative territory, with Continental Europe losing the most (-3.5%). Moreover, most REIT performances were behind returns carried by common shares. Only the U.K. was successful in posting an attractive total return of 3.8%, outperforming the MSCI U.K. index by over 3%.

With the many challenges the REIT market has been facing this month, investors need to revert to the basics.

Continental Europe is a fascinating example of this, as it would appear as though they are successfully reversing this downward trend thanks to real interest rates (nominal rates adjusted for expected inflation). Ever since the ECB put in place its QE program, the Euro area annual headline inflation has been at its highest since November 2014, coming in at 0.3% in May 2015 – the highest since November last year and above market expectations. Even the core inflation rate, which excludes the cost of energy, food, alcohol and tobacco accelerated from 0.6% to 0.9% in April (source: TradingEconomics). And a few weeks ago, long-term bond yields started rising, slightly narrowing the spread between gross dividend yields booked by REITs (or net property yields carried by the underlying properties) and long-term sovereign bond yields. Obviously, this is creating anxiety among investors.

In the United States, the Fed’s potential decision for some point this year, to raise the federal funds rate target and begin "the process of normalising monetary policy" is exciting considerable debate (source: speech by Chairwoman Janet L. Yellen at the Providence Chamber of Commerce, Rhode Island).

In China, housing markets are turning, marginally, more rosy, yet the key question here is whether or not this trend will be confirmed in the near future.

Although there is an acknowledged risk of modestly higher nominal interest rates in the mid future in the economically mature world, this scenario will not necessarily lead to higher real interest rates. And since the level of real interest rates is what really matters to property investors, it stands to reason that REIT properties ought to be financed at fixed interest rates. Given that rental properties are indexed (or reviewed upwards) in many countries of the world, should core inflation return to a reasonable level - which is the goal of various central banks, such as in Europe and Japan, property investors would fully benefit from the inflation-hedge characteristics of property.. Admittedly, renewed market volatility on the stock exchanges cannot be ruled out in the coming months.