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REITs poised to gain this year amid ‘decade-long’ valuation discounts: Hazelview

Corrado Russo, managing partner and chief investment officer at Hazelview Investments, talks about investment themes to achieve success in 2025.

Real estate investment trusts (REITs) could see significant upside in the year ahead, according to a new report, which says the sector is trading at the most favourable valuations in decades.

In a report released Tuesday, Hazelview Investments said that although REITs saw improvements in investor sentiment during the summer, a more cautious posture by the U.S. Federal Reserve in December spurred a pullback in the sector during the end of the year. The report notes that despite that, REITs finished the year a with a “mid-single-digit positive return.”

“We believe REITs still offer ample runway in the coming year, supported by robust fundamentals, and continued discounted valuations,” the report said.

One of the report’s authors, Corrado Russo, managing partner and chief investment officer at Hazelview, said in an interview with BNN Bloomberg Tuesday that the fundamentals are favourable.

“Demand continues to be very strong and growing, and that’s leading to ongoing occupancy and higher rent. But even more so on the fundamental side, supply is (at) one of the lowest levels we’ve ever seen. Obviously, given COVID-19 and then the higher interest rates, it’s made it very difficult to develop new assets in many of these sectors,” he said.

“We’re starting to see a shortage of supply come on the market. So as demand continues to grow, you’re going to have a situation where you’re outstripping supply, and that generally leads to higher occupancy and higher rents, which ultimately leads to higher cash flow growth.”

According to the report, the relative valuation backdrop for public REITs is “more compelling” this year than during any time over the past three years.

“(With) relative valuations at decade-long discounts after three consecutive years of underperformance, global REITs are trading at historically attractive levels relative to global equities... on a price-to-cash flow basis, global REITs are trading at their cheapest levels in over 20 years relative to global equities,” the report said.

“Similarly, on a relative EV/EBITDA (enterprise value to earnings before interest, taxes, depreciation, and amortization) basis, REITs are trading near historic lows compared to global equities.”

Hazelview said in its report that it believes the valuation disparity could lead to a re-rating over the coming 12 months, providing investors with the opportunity to increase exposure at attractive valuations.

“Our valuation models suggest that REITs are priced at a negative 17 per cent discount to intrinsic value (defined as a blend between NAV [net asset value] and cash flow), which implies a 20 per cent upside in price from current levels,” the report said.

“Over a two-year holding period, and inclusive of a 3.8 per cent dividend yield per annum, our valuation models forecast an annualized expected total return of 13 per cent to 15 per cent.”

The opportunity in the REIT sector comes after three years of economic volatility, the report said.

The authors also recommended active management strategies for investors amid differing regional growth prospects, sector fundamentals, company performance and central bank recalibrations.

Key themes

Some of the key investment themes for 2025 outlined in the report include global data centres, senior housing in North America, hotels in Japan, commercial real estate brokers, and residential real estate in Germany and Australia.

The report says data centres “represent one of the most compelling secular growth opportunities” across the REIT sector.

“Data centres are experiencing record demand from hyperscale customers and enterprise users driven by the growing utilization of digital applications, artificial intelligence (AI), cloud computing, and network connectivity,” the report said.

“Simultaneously, significant supply constraints caused by power availability issues and shortages of critical equipment are reducing vacancy rates and driving market rents higher across key markets.”

Russo also said that data centres can be a cheaper way to invest in the broader theme of AI enthusiasm.

“Data centres is one of the areas that we would highlight as having exploding demand, obviously through the hyperscale tenants like Google, Amazon, Meta. To us it’s kind of a much cheaper way to invest in the opportunity that we’re seeing in AI,” he said.

“You’re obviously seeing what’s happened to the valuation and growth of many of the tenants for data centres, but you look at, as they grow their AI capabilities, they’re going to require a lot more equipment, and that equipment requires so much power and so much cooling and redundancy that it has to be housed in data centres and that’s creating record low vacancies, which we expect to persist across U.S. markets like North Virginia, Phoenix (and) Dallas for example.”

Senor housing is poised to continue its gains from last year, the report said, with “powerful demographic tailwinds in both Canada and the U.S.” amid supply constraints.

Meanwhile, hotels in Japan, the report said, will benefit from a sustained growth trajectory in Japanese tourism.

“Strong inbound tourism from Western and Asian nations, the reopening of mainland China’s borders, and a favourable Yen exchange rate support higher tourist inflows and continued improvement in hotel demand, room rates, and occupancy in 2025,” the report said.

The commercial real estate broker sector is viewed by Hazelview as a “highly attractive investment opportunity in 2025.

“CRE brokers provide exposure to both a cyclical recovery in property transactions and leasing volumes, as well as the secular growth of facility and property management services for owners and occupiers,” the report said.

Lastly, the report said residential real estate in Germany and Australia offers opportunities for investors given structural supply and demand imbalances and demographic tailwinds.