Displaying items by tag: real estate

One of the biggest beneficiaries of the October CPI report was office REIT stocks as the sector saw double-digit gains due to the odds of further hikes diminishing, while expectations for cuts in 2024 increased. It marked the biggest gains for the sector since November 14 when the Covid-19 vaccine was announced.

One of the biggest headwinds for this group has been high levels of debt which is exacerbated by high interest rates. So, the relief rally makes sense given that lower levels of inflation would portend looser monetary policy and a decline in short and long-term rates. Many stocks in the sector have high levels of short interest which also make them more susceptible to big moves higher in the event of a positive catalyst. 

However, there remains considerable uncertainty over whether these gains will last given that the fundamental outlook remains impaired. Companies continue to reduce office space as remote and hybrid work arrangements have remained even after the pandemic. Prior to the pandemic, the office vacancy rate was at 9.4%, while it’s 13.5% currently. 

There’s little indication that this could change as demand for new office space is subdued. According to data provider VTS, the number of new searches for office space in major cities is 47% below pre-pandemic levels. 

Finsum: Office REITs have enjoyed a decent rally following the CPI report. However, the longer-term picture remains challenging with no rebound in sight for office space. 

Homebuilder sentiment declined to 34 in November as mortgage rates rose for most of the month according to a survey by the National Association of Homebuilders (NAHB). Anything below 50 is indicative of poor sentiment, however there was some optimism that the recent decline in rates may lead to an improvement in conditions. 

Higher rates have stifled demand and increased the cost of financing for homebuilders and developers. Another headwind has been low inventories, resulting in less transactions. Overall, the survey results declined from 56 in July to its current level. However, the survey does not reflect the recent decline in rates following the soft October CPI report. 

All three components of the survey showed weakening with sales conditions falling 6 points to 40, sales expectations over the next 6 months dropping to 39 from 45, and buyer traffic declining from 26 to 21. 

According to Robert Dietz, NAHB’s chief economist, “While builder sentiment was down again in November, recent macroeconomic data point to improving conditions for home construction in the coming months. In particular, the 10-year Treasury rate moved back to the 4.5% range for the first time since late September, which will help bring mortgage rates close to or below 7.5%.” He believes that a decline in rates, coupled with low inventories, could set the stage for a rebound in sentiment. 

Finsum: November’s homebuilder sentiment survey report came out and showed a major decline. However, there is some optimism that the recent decline in rates could lead to a rebound in sentiment in the coming months.

Based on research conducted by PGIM’s David Blanchett, Head of Retirement Research, and Sara Shean, the Global Head of Defined Contribution, there is a strong case that private real estate debt can be an effective source of diversification for fixed income portfolios, while also modestly boosting returns. It’s of increasing salience given that fixed income portfolios are once again a meaningful source of income for investors.

Blanchett and Shean conducted an analysis of various asset classes to determine how they would have improved the return and risk profile of a fixed income portfolio. They used the Bloomberg US Aggregate Bond Index as their benchmark. In addition to this benchmark and real estate debt, they also included emerging market debt, commercial mortgage-backed securities, leveraged loans, and high-yield bonds.

Interestingly, the benchmark had an annual return of 4% with a standard deviation of 4%. In contrast, private real estate debt had an annualized return of 6% with a similar standard deviation. The analysis also gives insight into the optimal weights of various asset classes in terms of impacting the efficiency of a bond portfolio. The biggest takeaway is that allocations to real estate debt led to a positive impact on risk and expected returns, leading to a higher risk-adjusted performance. 

Finsum: Research conducted by PGIM shows that private real estate debt can boost the risk and return profile of fixed income portfolios.

High rates have severely impacted the real estate market. In terms of commercial real estate (CRE), higher rates mean that financing costs have risen, but more pain will come when they have to roll over debt in the coming years, assuming that rates remain elevated. 

According to Rich Hill, the Head of Real Estate Strategy & Research at Cohen and Steers, Head of Real Estate Strategy & Research, REITs are in a much better position to handle these stresses than the larger CRE market. 

Many REITs have delivered their balance sheets with 86% of debt fixed for around 6 years which means there is much less exposure to interest rates than other CRE operators and investors. Additionally on the aggregate, REITs have a loan to value of 35% which is quite conservative relative to historical standards. 

So far, high rates have had a muted impact on earnings, about 1.4%, making it more of a mild headwind. Thus, valuations for REITs have become quite attractive, while they remain on strong footing fundamentally, especially in relation to the broader CRE market. As a result, Hill notes that valuations for REITs have stabilized, while private valuations continue to move lower. 

Finsum: High rates are leading to significant amounts of stress for parts of the commercial real estate market; however REITs have been less affected so far. 

Many investors are hopeful that inflation will continue moving lower which will provide relief for fixed income and equities as the Fed could start loosening monetary policy. However, KKR does not believe it’s likely. Instead, they believe we are in the midst of a ‘regime change’ in terms of the macroeconomic landscape which will require investors to adopt new portfolio management strategies.

In essence, they see inflation being structurally higher due to factors such as entrenched fiscal deficits, labor shortages, energy transitions, and increased geopolitical risk. With these conditions, stocks and bonds are more correlated as evidenced by the last 2 years. The firm believes that investors need to increase their allocation to real assets with recurring yields as a source of diversification, given the increase in bond market volatility. 

Rather than the traditional real assets such as REITs, TIPs, and precious metals, they find value in real assets that have collateral-based cash flows like private real estate to provide positive returns while dampening portfolio risk. 

Even if their outlook on inflation proves to be incorrect, KKR believes that real assets should outperform given that they remain bullish on economic growth and see Q4 and 2024 GDP coming in above expectations. 

Finsum: KKR is bullish on real assets including private real estate as it believes inflation is going to remain structurally high and that bonds are not providing sufficient diversification.