We came into 2024 expecting an inflection point in the commercial real estate sector following two years of declines in the face of rising interest rates. As we stand today, this thesis seems to be playing out, albeit it’s been a year of ‘stop and start’, with geopolitical concerns and the markets’ expectations around rates oscillating, driving short-term sentiment toward listed real estate investment trusts (REITs).

One property CEO recently commented to us, “a lot of lights are now turning green”. Looking ahead, we’d like to highlight three key messages that continue to give us cause for optimism into 2025:

1. We believe we have seen the bottom in most real estate property types and geographies – we are at the beginning of a new commercial real estate (CRE) cycle. Valuations have largely been reset and transaction volumes are increasing, with a greater breadth and depth of demand across investment markets. Higher transaction volumes should result in a firming and eventual increase of asset values. While rising interest rates necessitated the downward reset in real estate valuations, they also have made construction financing prohibitively expensive in most jurisdictions. Inflation has increased the cost of raw materials and labour required to build. As a result, many property types have seen new development starts grind to a halt, which means supply growth is likely to broadly decelerate for the next few years. Less oncoming supply and steady or growing demand is a recipe for increasing landlord pricing power in the years ahead.
2. We continue to expect listed REITs to lead the recovery in CRE. Companies from property sectors that have benefited from structural trends, employed lower leverage (debt), and enjoyed an advantage in terms of cost and access to capital, with a pathway for growth have seen share price appreciation from the market. Welltower (US senior housing) successfully leveraged its best-in-class operational platform with more than US$6bn of accretive acquisitions (YTD through 3Q 2024) in a sector facing demographic tailwinds and limited new supply in the years ahead. Goodman Group in Australia has leaned into data centres as a pathway for further growth, with a pipeline in excess of 2.5GW. Meanwhile, Unite Group in the UK has partnered with capital-constrained universities to provide a solution to student housing needs.
3. Listed REITs have continued to provide defensive and growing cash flows and dividends. The underlying operational fundamentals of many businesses remain robust, with occupancy high and rents rising. These factors can enable further cash flow and dividend growth in the year ahead. While the defensive nature of this cash flow has perhaps been a little unexciting in an equity bull market like 2024, it’s worth remembering the significant outperformance of listed REITs in spring/summer as the market became concerned about employment and economic growth prospects.¹ In a year of broad-based positive returns and enthusiasm, having an allocation to an asset class that offers some diversification in the ‘What if?’ scenario we think, remains valuable.

The key reasons above lead us to think that real estate ‘works’ again from today’s valuations because listed REITs have been repriced for the current interest rate environment. High and growing dividend yields, defensive income streams and diversification versus the wider equity market, all support an allocation within a balanced portfolio.

Underlying real estate fundamentals remain steady; coupled with new growth opportunities ahead for the listed REIT sector, we believe the asset class can continue to outperform other forms of property ownership. Share valuations have rarely ever been more discounted relative to broader equities, while interest rates have turned from a headwind into something looking more supportive.

We may not yet be “off to the races” in the listed REIT sector, but more lights are turning green.

IMPORTANT INFORMATION

REITs or Real Estate Investment Trusts invest in real estate, through direct ownership of property assets, property shares or mortgages. As they are listed on a stock exchange, REITs are usually highly liquid and trade like shares.

Real estate securities, including Real Estate Investment Trusts (REITs), are sensitive to changes in real estate values and rental income, property taxes, interest rates, tax and regulatory requirements, supply and demand, and the management skill and creditworthiness of the company. Additionally, REITs could fail to qualify for certain tax-benefits or registration exemptions which could produce adverse economic consequences.