Secular demand trends and accommodative financial conditions expected to support REIT cash flow growth and share prices
The eruption of tensions between the U.S. and Iran was likely a rude awakening for many investors, if the recent swing from risk assets to havens is anything to go by. For those paying attention to forecasts of slowing economic growth, it may have provided yet another reason to seek exposure to alternative assets, which would mean cutting back investments in public equities.
But according to a new report from Timbercreek Asset Management, investors can still expect global REITs to deliver double-digit returns over the coming year.
“[W]e believe global REITs are positioned to deliver another year of double-digit total returns (10% to 12%),” the firm said in its Global Real Estate Securities 2020 Market Outlook.
The current cycle is long by historical standards, the report noted, adding that global economic activity has shifted to a slower but steady pace compared to recent years. But central banks still stand ready to hold interest rates until both growth and inflation recover, providing an opportunity for REITs to continue benefiting from secular demand trends.
“[S]trong global labour trends and consumption are positively influencing commercial real estate fundamentals and demand for residential housing,” the report said. “We believe this bodes well for REIT cash flow growth and share prices over the next 12 months.”
Consensus estimates for real GDP growth among developed countries this year stands at 1.4%, down from 2.2% in 2018; including emerging markets, the estimate rises to a still-slow 2.5%. REIT outperformance typically grows in magnitude and frequency in a modestly growing economy, according to the report.
Because REIT cash flows are tied to contractual leases, the report added, they were able to deliver stronger absolute earnings growth in 2019. In comparison, equities saw a material decline in the rate of earnings growth compared to double-digit increases that came in 2017 and 2018. “[A]s we look toward 2020, we anticipate REITs will deliver ~5% earnings growth, attractive on an absolute basis and resilient on a relative basis should the global economy experience further hiccups,” the report said.
Timbercreek also expressed its belief in REITs as a solution to a yield conundrum facing investors — take on more risk or lower their long-term return expectations — as interest rates around the world are expected to remain lower for longer. It cited nearly 4% yield currently observed in the global REIT market, with dividends growing at around 5% and as much as 10% to 20% per annum in segments such as tech-focused REITs.
And despite their recent outperformance, REITs’ relative price-to-cash flow multiples are still slightly below their long-term average. “We believe that in a more modest growth environment, REITs can trade at premium multiples to their long-term average,” the report said.
Cash available for private real estate transactions also continues to rise — it recently crossed US$300 billion for the first time, opening the door for more than US$650 billion of purchasing power on a 50% levered basis. Approximately 800 funds are also currently in the process of raising capital, with a cumulative targeted raise of just over US$250 billion.
“We believe a portion of this capital will make its way back into the global REIT market through M&A, the acquisition of REIT assets or joint ventures that lead to additional growth opportunities for REITs,” the report said.