Despite real estate investment trusts (REITs) facing headwinds over recent years, a report says the sector could be at an inflection point given the current macroeconomic outlook.
On Aug. 9 Hazelview Investments released a report on opportunities in the REIT sector. The report said that despite challenges over the past few years, REITs now offer a “compelling case for investing” amid healthy fundamentals, low valuation multiples and a “more favourable” outlook for capital markets and macroeconomics.
“The overall tailwinds for real estate and recent activity we are seeing in the market may finally signal an inflection point for REITs. This combination of factors makes it an opportune moment for investors to consider allocating to this asset class,” the report said.
Samuel Sahn, a managing partner and portfolio manager at Hazelview Investments, said in an interview with BNNBloomberg.ca on Monday that over the last two and a half years, REITs and real estate as an asset class have suffered a “significant valuation decline.”
He added this was due to monetary tightening, with central banks around the world raising borrowing costs to quell inflationary pressures. However, according to Sahn, this could be changing.
“Macroeconomic conditions are starting to shift in the favour of interest rates-sensitive industries like real estate, like REITs,” Sahn said.
“After two-and-a-half years of underperformance, which has resulted in significant multiple compression, we think REITs are poised to deliver, by and large, significant outperform over the next several years as those discounted valuations dissipate and those historically low multiples start to get back to where they historically traded and in some cases a premium.”
Other industry players are also seeing the expected path of interest rates as a tailwind for the sector.
Dennis Mitchell, CEO and CIO at Starlight Capital, told BNN Bloomberg last week that the Bank of Canada’s pivot to rate cuts continues to spur the real estate sector.
“So when we look at our fund, since the Bank of Canada started the rate cut cycle in May, the fund has outperformed the benchmarks significantly.”
Underperformance
The report said that REITs have significantly underperformed compared to other assets like global equities due to a few key factors including the COVID-19 pandemic and subsequent rise in interest rates.
“This monetary tightening has caused property values to decline and increased borrowing costs for REITs, creating a headwind to earnings and making it more expensive to finance operations and acquisitions,” the report said.
However, the report said depressed REIT prices coupled with the possibility of future rate cuts “present a considerable opportunity for investors.”
“Given recent underperformance and the evolving macroeconomic and capital markets environment, we believe REITs may be at an inflection point,” the report said.
“Current valuations are attractive due to past underperformance, operating fundamentals remain resilient and with recent interest rate cuts in Canada and Europe, as well as anticipated cuts in the U.S., the environment is becoming increasingly favourable for REIT investments and the prospect for higher asset values.”
Other factors
Sahn highlighted that there are also other factors contributing to opportunities in the REIT sector.
“I would say the lack of new supply is going to be a big benefit for (REITs) because you’re already starting to see its influence on NOI (net operating income) margins (and) its influence (on the) bottom line,” he said.
“The other nuance is refinancings that are coming due over the next few years, as rates come down those debt headwinds dissipate and when those refinancing headwinds dissipate, more of the cash flow that’s generated on the top line will fall to the bottom line.”
Public real estate market
Sahn noted that public real estate markets also allow investors to get exposure to certain industries and property types they may not otherwise be able to access.
He said that through investing in REITs individual investors can get exposure to industries like senior housing in the U.S. and Canada as well as data centers around the world.
