Real estate investment trusts (REITs) could be on the cusp of a new "golden era" in 2025, despite recent challenges in the sector, according to Matthew Sgrizzi, CIO and portfolio manager at LaSalle Investment Management Securities.
Mr Sgrizzi and his team at LaSalle have identified four common elements that have preceded strong performance by REITs: a dislocation of bank lending to real estate; broad-based negative sentiment around real estate; underperformance versus broader equities; and an easing or reset of financial conditions.
“Pattern recognition is a useful approach that can help in predicting regime shifts in market conditions. Our study of historical periods of listed REIT under- and outperformance identifies a clear pattern. Namely, there are four common factors that have driven REIT strength after a period of challenges,” said Mr Sgrizzi.
“The current environment resembles the set up for these historical golden eras, suggesting REITs may be on the cusp of its next golden era of investment. Many of the factors supporting the REIT market’s upbeat prospects are also positives for real estate as a whole. For example, an easing in financial conditions has historically been a driver of strong forward REIT returns, as well as those for private equity real estate.”
According to Mr Sgrizzi, the past few years have seen a significant retrenchment in bank lending to real estate. According to the US Senior Loan Officer Survey, the net balance between demand for loans and banks' willingness to lend points to the widest undersupply of credit in the past ten years, except for during the depths of COVID-19.
“This situation presents an opportunity for REITs, given their strong financial positions. Global REITs entered the recent tightening cycle with their lowest leverage levels on record, and nearly 90 per cent of their debt on fixed rates and an average remaining term of seven years," he said.
In terms of REIT underperformance relative to broader equities, this has reached typical peak historical levels before reversal. "Periods of underperformance have historically tended to reverse and this instance is no different with the performance gap already narrowing," Mr Sgrizzi said.
In addition, a global monetary easing cycle is now well underway, which historically bodes well for REITs.
“Real estate is a capital-intensive business that is sensitive to changes in financial conditions, an observation that holds true for both directions of interest rate change. The downside of this was evident in 2022 and 2023, but the upside is likely coming into play. A global monetary easing cycle is now underway, with several central banks cutting rates. Historically, REITs perform well well in periods leading up to and following a central bank easing cycle.”
Over the past 25 years, REITs have produced total returns of 8 to 9 per cent per annum. Looking ahead, Mr Sgrizzi projects that his base case underwriting for the next three years is for the REIT market to produce total returns in line with those historical averages, with roughly four percentage points of that coming from income.
“If financial conditions were to ease further, these return expectations could increase to the mid- to high teens range per annum, which aligns with previous ‘golden era’ REIT performance,” he said.
“Investors are advised to consider REITs as part of a diversified portfolio, particularly given the sector's current valuations and potential for recovery in the evolving economic landscape. While history does not repeat itself, it does often rhyme, and we believe we are on the cusp of the next ‘golden’ era,” he said.
