With North American equity valuations creeping ever higher and global stock markets showing signs of volatility, advisors are under pressure to find some alternative ways to generate returns. There seems to be widespread acceptance that we’ve entered a period of reinflation and investors are moving out of the traditional yield vehicles: since the election south of the border the U.S. ten year has increased from 1.77% to 2.40%.
Real estate, and REITs in particular, have been swept up in the noise around reinflation and there is a belief amongst some that a rising interest rate environment is bad news for real estate; that real estate is incrementally less attractive if you can get a higher yield on fixed income. As a result, when interest rates are raised, REITs tend to sell off, despite the fact there is no evidence linking increasing interest rates to decreasing real estate values over time.
“In the last 20 years, there have been seven major periods of interest rates rising: REITs performed positively in six of those periods and outperformed the stock market in five,” explains Joshua Varghese, CFA, Portfolio Manager at CI Investments
Inc. “If the economy is improving, a real estate company should be able to capture that by charging higher rents. When interest rates increase, revenue lines also increase and that is what happened in those times.”
Varghese doesn’t agree with those who see danger ahead in the real estate market, but does concur that lower interest rates and financing costs have pushed people into real estate over the past seven years. He does believe, however, that the tailwind is diminishing and that glboal real estate prices are due to cool off, although he doesn’t envisage a situation as dire as some headlines would suggest.
“A real estate company with a well located asset is going to be able to benefit from the economic improvements that are happening right now,” Varghese, who was a recent speaker at CFA Society Toronto’s Equity Investment Symposium, says. “There are real estate assets that will be more fortunate than others, there will be winners and losers. However, real estate values are relatively underpinned in a band and that opens up opportunities in publically traded real estate companies that are trading at discounts to the value of their property."
"If those companies are run by a capable management team, they’re a good investment.”
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