Jason Yablon of Cohen & Steers says the market cycle is turning in favour of listed real estate and offers three key proof points for why investors should increase allocations.
For more than a decade following the global financial crisis (GFC), low inflation and supportive central banks encouraged investors to eschew diversification and embrace equity risk and leverage.
More recently, investors have been concerned about allocating money to listed real estate in an environment of “higher for longer” interest rates. In fact, real estate has not been this under-owned since the global financial crisis.
Markets, however, are in the midst of a regime change and recent market volatility brings the point home.
The rate-hiking cycle ended months ago, and slowing economic data put the Fed on track to the rate cut in September this year. The global economy, which has proven far more resilient than most observers predicted, is slowing—the result of two years of aggressive central bank actions.
In this new regime, diversification will be more important, and investors should carry more fixed income, real assets and cash in their portfolios at the expense of equity risk. In particular, the market cycle is turning in favour of listed real estate investment trusts (REITs).
Regime shift to lower rates
There are three key proof points of a new regime for REITs. First, a regime shift to lower rates is a favourable backdrop for REITs.
Interest rates—which dictate the financing costs of real estate—are a key driver for real estate asset values and REIT returns. Lower interest rates reduce borrowing costs for REITs, enabling them to finance acquisitions and developments more cheaply and support asset values.
Notably, since 1990, listed REITs have had average annualised monthly total returns of 18.9% when growth and yields were down, which is the environment we are entering. By comparison, listed REITs have had average annualised monthly returns of -11.7% when growth was down but yields were up (the environment the market is moving away from).
Additionally, falling rates typically increase the attractiveness of REIT dividend yields, compared with other fixed income and cash-equivalent securities. This dynamic can drive higher demand for REIT shares, pushing up prices and enhancing total returns for investors.
REITs, which have historically traded at an earnings multiple premium to stocks, are currently at a discount. That rarely happens.
REITS are at a rare discount to stocks
Second, REITs are attractively valued, particularly relative to equities and private real estate.
Stocks have outperformed listed REITs for an extended period, but this trend is unsustainable. REITs, which have historically traded at an earnings multiple premium to stocks, are currently at a discount. That rarely happens.
As of June 30, U.S. REITs were trading at a -5.8x earnings multiple spread to equities broadly, compared with the historical average of 0.5x. This is a strong forward indicator for listed REITs—in fact, while past performance is not an indicator of future results, REITs have returned 19.2%, on average, in the 12-month periods following REIT multiple discounts of this magnitude. (In the same periods, U.S. equities returned an average of 11.0%.)
Comparisons with private real estate also look favourable. While many have tried to make the case that U.S. private real estate values have bottomed – private real estate could still fall further. Listed markets typically bottom around a year before private real estate. Listed REITs bottomed in late 2023, and we believe private real estate prices will continue adjusting through 2024 and potentially into 2025.
REITS are positioned to be net acquirers
Third, publicly traded REITs are well positioned to go on acquisition offense.
The cost of financing on the unsecured bond market is attractive. Credit spreads are tight. And, as a result, listed REITs are positioned to be net acquirers in this cycle.
Recent capital market activity further demonstrates listed REITs’ strength and ability to deploy capital.
Most notably, the recent IPO of Lineage, the world’s largest operator of cold storage warehouses, highlights the strength of REIT capital markets. Lineage raised $5.1 billion, marking this the largest public offering of 2024 and the largest REIT IPO ever.
Other capital markets activity also indicates the strength of listed real estate. Publicly traded Equity Residential agreed to purchase a nearly $1 billion apartment portfolio from Blackstone, demonstrating the listed markets’ ability to provide liquidity to private assets. Meanwhile, Welltower has gone on a $5 billion acquisition hunt, utilising its lower cost of debt to expand its national footprint of senior housing.
The allocation opportunity
Allocations are likely to change. Lineage’s IPO is a powerful indicator of the strength and resilience of REITs in today’s market. With strong fundamentals, attractive valuations, and the potential benefits of a rate-cutting environment, REITs present a compelling investment opportunity.
Markets are beginning to price in the REIT regime shift. Listed REITs rose by 7.2% in July as the CPI data softened, marking the third consecutive month of positive returns. Within the month, they outperformed the S&P 500 by 596 basis points and the Nasdaq by 790 basis points. Real estate was the best-performing sector of the eleven S&P GICS sectors.
*Jason Yablon is head of listed real estate at Cohen & Steers.
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