The report suggests that the REIT market’s turnaround will be fueled by “resilient corporate earnings” amidst slower economic growth, falling interest rates, and a significant lack of new real estate supply.
“The shifting tides of economic and monetary conditions, coupled with compelling valuations, create a canvas for strong performance in the REIT market in 2024,” says Corrado Russo, Managing Partner and Head of Global Securities at Hazelview Investments, in a press release accompanying the report.
“Navigating this landscape with precision and seizing the opportunities it presents defines our approach. This is not just a moment — it’s an extraordinary market opportunity and we are poised to capitalize on it.”
The report highlights the significant upside potential of undervalued REITs, which are currently priced at a high double-digit discount relative to their underlying value (a blend of net asset value and discounted cash flow), implying an upside potential of approximately 22%.
Hazelview Investments asserts that this historically unusual market distortion provides investors with a remarkable opportunity to invest in severely underpriced REITs, which are expected to gain additional upward momentum from anticipated central bank interest rate cuts in 2024.
The transition towards a declining interest rate environment comes after two years of economic uncertainty and investor confusion due to a significant surge in global inflation rates and correspondingly hawkish central bank monetary policy.
This led to what the report describes as a “significant disconnect between public REIT and private market real estate valuations.”
Similar decoupling dynamics were observed during the 2007-’08 global financial crisis (GC) and the 2020-’22 COVID pandemic.
In both cases, public REIT share prices initially experienced steep declines but later rebounded to outperform the market, corresponding to a narrowing in the valuation gap with respect to the private REIT market.
The report suggests that the anticipated slowdown in global GDP growth in 2024 – citing J.P. Morgan’s conservative 2.2% prediction, notably lower than the IMF’s 2.9% forecast and Goldman Sachs’ 2.6% estimate – should provide The Fed and other central banks with ample room to cut rates further and faster to avoid any possibility of a recession given the lag effect of high interest rates in 2023.
“Looking back at central banks’ five waves of interest rate hikes since 1995, REITs were able to deliver the strongest returns in the wake of pauses to those campaigns. This is a key historical point that underlines the opportunity ahead for REITs as an asset class,” the report states.
This shift in interest rate policy is also expected to suppress bearish investor sentiment towards REITs, which saw a significant increase in redemptions in 2023.
Some clients were grappling with higher costs on variable-rate debt, while others sought safer returns on fixed-rate investments yielding five per cent returns.
“We’re now seeing a pause in interest rates and as we start to look towards potential cuts in central bank rate(s), I think that’s going to have a very positive impact on cost of capital.
“Just as the pendulum swung pretty aggressively the other way in 2022 and 2023, there’s some significant upside as we head in the other direction,” Russo told RENX in an interview.
This process has already started in earnest as of November and December when Global REITs recorded an impressive gain of 18.9% to conclude 2023 with an overall increase of 10.8%.
“Even in the unlikely event of an economic downturn, REITs have historically shown resilience during recessions due to the predictable cash-flow stream from long-term leases. This is because tenants in the real estate sector have a legal obligation to pay rent. Therefore, a downturn could potentially be beneficial,” Russo added.
The report also points out that the inflationary environment over the past year and a half has significantly increased construction costs due to higher borrowing costs. This has led to a decrease in construction activity, which will reduce supply growth in the residential and commercial real estate sectors, while demand is expected to remain stable or even increase.
“Driven by a robust global economy and the anticipated decrease in supply growth, this could lead to an increase in REIT values,” the report suggests.
“In essence, the reduction in construction will further emphasize the imbalance between supply and demand in key regions and property types.”
Russo also downplays the impact of high office vacancy rates on the REIT market, arguing that sensational headlines about significant increases in office vacancies are exaggerated.
“Office spaces will face challenges, but they constitute a very small portion of the real estate universe. For instance, the U.S. REIT market, which makes up 60% of the global REIT market, only has 2-3% of its portfolio in office spaces,” Russo explained.
“Regrettably, even though office spaces are essentially irrelevant to REITs, such news has generated a negative sentiment towards real estate in general.”
Hazelview Investments, a global real estate investment fund manager, currently manages $12.1 billion in real estate assets. The company, headquartered in Toronto, employs a team of over 80 investment and asset management professionals and has offices in New York, Hong Kong, and Hamburg.
Russo acknowledges that the report’s highly optimistic projections for the REIT market in 2024 contrast with the company’s inherently conservative investment philosophy.
“We tend to be more conservative by nature – it’s part of our identity,” Russo elaborated. “When we underwrite, we don’t rely heavily on growth to justify the prices we pay for companies. However, despite the rising cost of capital, we’re noticing that many companies are trading at attractive valuations.”
“I must admit that I’m extremely bullish for 2024. In fact, I’m more optimistic than I’ve been in the 30 years I’ve been in this field. When I consider the potential for rental growth in most real estate areas, the appealing valuations, the underperformance of REITs compared to equities over the past few years, and the gap between REITs and private real estate, it seems like all the stars are aligning for a strong bull run. Most of these factors have been aligning over the past year. The only missing piece was interest rates, which have been the most significant negative factor affecting investor sentiment towards REITs. However, the harsh headwind of high interest rates is set to become a tailwind over the next 12 to 24 months.”
