Real Estate Investor Magazine South Africa June/ July 2019 | Page 47

L
ike many asset classes, real-estate investment trusts (REITs),
find themselves at an important juncture in 2019. The po-
tential for rising interest rates over the medium to long-term
is threatening the strong returns achieved from this asset class over
the last decade. This comes at a time of stretched valuations, adding
further risk to an already complex setting.
Insight from Morningstar Investment Management(MIM),
reveals that investors lack conviction in global REITs, although the
company sees relative value in retail property and South African
REITs. A quick scan of the globe shows that Hong Kong has
been the best performing REIT market over the 12-month period
ending February 2019. ‘With ongoing trade wars between the U.S.
and China, this result shows that investors are favouring domestic
assets which are likely to be less impacted by these tensions,’ says
Eugene Visagie, Portfolio Specialist at Morningstar Investment
Management.
The market expectation that the U.S. Federal Reserve will delay
raising interest rates is another reason why we are seeing this shift.
On the local front, and in contrast to Hong Kong, South African
REITs were among the worst performing region. ‘Although this
is perhaps nuanced by a large sell-off in early 2018 due to reports
from Viceroy around certain valuation principles followed by listed
property providers,’ says Visagie.
Over the next decade, MIM believes that REITs are likely to face
two significant headwinds. The first is a predisposition of stretched
valuations and reasonably high debt, and the second is a vulnerable
growth rate that could easily move back towards trend and result in
pockets of divergence.
Market darlings at the moment include industrial REITs,
however MIM feels that investors should be aware that it is currently
a relatively crowded trade. When considering industrial REITs,
investors with unique and well positioned assets, such as those near
ports, are less susceptible to supply competition.
Put together, the large price increases over the past five years may
unwind, posing a potential danger to real estate investment. ‘In addition,
we’d add that new construction has been moderate - approximately in
line with demand - keeping vacancy rates stable combined with rising
rental charges,’ says Visagie. He says that any increase in interest rates,
which could be reasonably expected over a 10+ year period, would pose
a challenge to REITs pricing going forward.
Risks faced by the listed property market
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Rising interest rates over the medium to long-term,
especially in the U.S. market
Slowing economic growth or an inflation shock
(particularly in the U.S. or China)
Already stretched valuations (particularly following the
large jump in January 2019)
Retail pressure, especially in developed markets. For
example, the trend in the U.S., Australia and U.K. is to have
destination malls with more food and service.
Morningstar provides context by reflecting on the Global
Financial Crisis (GFC), where many of the largest REITs in the
U.K. and Australia had to undertake ‘rescue’ rights issues due to
high gearing levels involved in the sector. This was exacerbated by
the significant devaluation of properties at the time. ‘Given a similar
setting today - with stretched property valuations, a continued
reliance on debt and an asset class that is sensitive to interest rate
changes - it should not be controversial to say that leverage concerns
could resurface if asset valuations were to fall significantly from here,’
warns Visagie.
So, where are we currently seeing opportunity?
Value-orientated investors may find opportunities amongst retail
REITs and/or South African REITs, however there are risks that
need to be balanced with the potential reward. ‘Taking these factors
into account REITs can be a diversifying asset in a multi-asset
portfolio but MIM are of the opinion that high valuations would
lead to adopting a lower weight at the present time,’ concludes
Visagie.
The REIT sector has grown significantly over the last two decades;
both in terms of REITs being introduced in new countries, as well
as the increase in the size of the sector across existing jurisdictions. It
is currently estimated that the global REIT market exceeds US$1.2
trillion.
The bulk of these assets remain in the U.S. (more than half of
the global REIT market), however other prominent markets include
Europe (both the Euro area and U.K.), Hong Kong, Australia,
Singapore, Japan and smaller markets such as South Africa.
SA Real Estate Investor Magazine JUNE/JULY 2019
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