With decent returns hard to find in traditional markets, many investors are being forced to look to alternative investment instruments. REITs, in particular, are a tool that many advisors are now paying close attention to as clients demand the sort of returns they enjoyed in previous times. Expected to underperform this year on the back of the Fed’s tightening cycle, REITs have in fact performed strongly and generated a total return year-to-date of 4.5%, which is very competitive with the general market.
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“You would think in a year where the Fed has hiked rates once and is anticipated to hike them twice more that REITs would be out of favour and underperform materially, but we’re actually seeing them hold pace,” says Dennis Mitchell, Senior Vice President and Senior Portfolio Manager for Sprott Asset Management. “In fact, our fund is up about 5% and change year-to-date.”
One wider economic theme that Mitchell is observing as he seeks out opportunities in the REIT space is the under performance of the retail sector. As a result, retail REITs (some of which are the biggest in western based economies) have performed poorly so far year-to-date. However, with domestic consumption accounting for 60 - 70% of GDP in the west, investors are advised not to turn their backs on retail REITs. Making the right investment decision is, however, more important than ever.
“If a retail REIT can operate its centres properly, get the right tenant mix and find locations in the right jurisdictions, it is going to offer some real opportunities,” Mitchell says. “The biggest REIT in the world – the Simon Property Group Inc. - owns some truly spectacular retail assets across the US, Europe and Asia. It also has interest in a French REIT called Klépierre, a name that is trading at a material discount to its NAV despite the fact that it’s growing its cash flows, net operating income and cap rates remain low.”
Some investors lump REITs in with bond proxies like utilities and telecoms, which Mitchell believes is misguided. He doesn’t see REITs as being as interest rate sensitive as many perceive them to be and gives the example of hotel and apartment REITs, which have the ability to reprice their revenue streams daily (hotels) or yearly (apartments).
“That means they have the ability to keep pace with growth, rising interest rates and inflation,” Mitchell says. “I would agree that REITs are interest rate sensitive because they do tend to have more leverage in their capital structure than traditional operating businesses, but that’s due to the consistency and transparency of their cash flows. They have contractual income streams and there is growth to those streams. That is what insulates them from rising rates and inflation.”