Economy
A recent report on real estate holdings of institutional investors revealed that while their allocation to the asset class remained level from 2022 to 2023, the allocation in the preceding decade increased by 190 basis points, a jump of 20%.
Historical data underscores the potential benefits of private real estate. A whitepaper from TIAA—a respected organization established by Andrew Carnegie in 1918 to support teacher retirements—highlights the performance of private real estate over a two-decade span. From 2000 to 2020, private real estate exhibited a very low correlation with stocks, bonds, and listed REITs. This suggests that incorporating private real estate into a portfolio could enhance diversification, which is crucial for managing risk.
Moreover, private real estate has traditionally been an effective hedge against inflation. As inflation erodes the purchasing power of money, the tangible asset class of real estate often sees its value and the income it generates keep pace with or exceed inflation rates, thereby preserving the real value of an investor's income.
For financial advisors, the strategic inclusion of private real estate in client portfolios can provide a twofold advantage: diversification benefits and protection against inflation. This can be especially valuable during periods of market volatility and rising prices, helping clients to achieve a more stable and resilient investment outcome.
Finsum: Real estate’s diversification and inflation hedging benefits are among the reasons why institutional investors continue to maintain their increased allocation to the asset class.
Institutional investors and money managers came together at the annual PERE America Forum and shared some thoughts on the private real estate market. The overall sentiment is that conditions will remain challenging until 2025 due to a large amount of commercial real estate debt that needs to be rolled over or refinanced at much higher rates.
According to John Murray, the head of PIMCO’s global private commercial real estate team, the situation is as bad as the Great Financial Crisis in terms of dislocations in capital markets. He notes that Fed policy is the major headwind, and its ‘crushing’ sentiment and liquidity.
Sajith Ranasinghe, head of real estate at Church Pension Group, remarked that price discovery has been limited so investors are focusing more on income. He also expressed interest in private REITs which are down over 30% since rates began moving higher in 2022.
Saul Lubetski, the vice-chairman of Harbor Group International recommends a ‘scalpel approach’ as $1.5 trillion of maturities are set to expire by 2025. He notes that the refinancing has already begun, albeit at a smaller and slower pace which should accelerate this year. However, it’s increasingly evident that borrowers are finally making peace with higher rates.
Finsum: At the annual PERE conference, institutional investors and money managers gathered to share some thoughts on the private real estate market.
Ivy Zelman is one of the top forecasters when it comes to the housing market. She’s made several prescient calls during her career including the housing bubble in 2006, the recovery in 2011, and recent pullback. She has been caught off guard by the resilience of home prices in 2023 despite a year of numerous challenges including high rates and a slowing economy.
For next year, she sees this strength continuing as affordability improves with falling rates, leading to a modest acceleration. She’s forecasting the 30-year fixed mortgage rate to fall to 6.4%, home sales growth to hit 5%, and prices to rise by 2%. In terms of the broader economy, her base case scenario is that current economic conditions prevail, and the Fed is successful in achieving a soft landing.
While many are focused on the current low levels of housing inventory, Zelman notes that new construction is at the highest levels since 2007. She believes that large amounts of supply will be an issue in the long-term, leading to a glut. According to her, current demand estimates are based on an incorrect figure of 1.5 million units needed annually. Instead, she believes that slower population growth will translate to slower household growth, leading to lower levels of long-term demand.
Finsum: Ivy Zelman is bullish on housing in 2024 due to falling rates and a better than expected economy. While the housing market is dealing with low levels of supply in the near-term, she believes that longer-term, excess supply is a concern.
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Rich Hill, the head of Real Estate Strategy at Cohen & Steers, shared his bullish outlook for REITs in 2024. He sees falling interest rates, tightening credit spreads, and undervaluation as the biggest catalysts for significant gains over the next year. However, he cautions that office REITs have their own dynamics due to vacancy rates remaining elevated amid the increase in remote and hybrid work.
REITs benefit in two ways from lower rates - their yields become more attractive to investors on a relative basis, and it leads to lower financing costs. Hill points to improving credit markets as another reason to overweight the sector in the coming year. This means REITs will have an easier time accessing credit which will lead to more activity such as acquisitions and new projects. Historically, REITs have outperformed during periods of tightening spreads and falling rates.
Another attractive component of REITs is that valuations are compelling as prices have declined over the past couple of years, while earnings have remained quite stable due to the economy avoiding a recession. Further, most REITs continue to have a relatively low cost of capital due to refinancing at lower rates in 2021.
Finsum: Rich Hill of Cohen & Steers is bullish on REITs for next year. He sees falling rates, tightening credit spreads, and an improving credit markets as major catalysts.
There was a major turnaround for US REITs in November as the industry raised $5.1 billion of capital compared to $1.3 billion in October. It was also an 89% increase from last November’s figure of $2.7 billion. YTD, the sector has raised $53.4 billion in capital, an 18% increase from last year’s first 11 months.
Nearly all of the capital raising came from debt issuance with the remainder from common and preferred equity offerings. The biggest contributors were hotel landlord Service Properties Trust and mall owner and operator Simon Property Group who raised $1 billion each. Realty Income Group raised $951 million through two separate debt offerings.
YTD, the biggest debt issuance has been Uniti Group’s $2.6 billion at the start of the year. And the biggest capital raiser has been American Tower at $7.1 billion followed by Prologis at $5.4 billion.
In terms of subsectors, specialty REITs, which encompass advertising, casino, communications, datacenter, energy infrastructure, farmland, and timber, had the most capital raised at $17.4 billion. Next was retail REITs at $9.4 billion, followed by industrial REITs at $7.9 billion.
Finsum: November was a successful month for REITs in terms of capital raising, significantly better than last month and last year. Nearly all of it was through debt issuance.
REITs have seen big gains in recent weeks with the FTSE Nareit All Equity index up nearly 12% in November and now green on the year. The major catalyst for recent gains has been increasing certainty that the Fed is nearing the end of its hiking cycle and may begin cutting rates by the second half of next year.
According to the REIT industry association Nareit, this strength will continue in 2024. In its outlook piece for next year it said, “We are cautiously optimistic that despite those challenges, the REIT recovery could begin next year. The impressive performance of REITs during late October and November may be a signal that, as in previous periods of monetary policy adjustments, the end of the rate-rising cycle will herald a period of REIT outperformance.”
Based on historical precedent, REITs have returned 20% over the next year following when rates stabilize which is better than stocks and private real estate. It also forecasts the performance gap between public and private real estate shrinking during this period. However, John Worth, Nareit’s executive VP of research and investor outreach, warns that these returns will be lumpy which means that investors will be rewarded for being in the market rather than timing the market.
Finsum: REIT stocks are seeing a strong rally in recent weeks amid optimism that inflation is falling and that the Fed is done hiking rates. Here’s why some see it extending into next year.