Economic and technical setbacks set the stage for active managers to pick their spots in publicly listed real estate
Some have called 2022 the perfect storm, and others have cited Murphy’s Law, but Sam Sahn won’t mince words in summarizing how things went for REITs last year.
“Everything that could go wrong, did go wrong,” the managing partner and senior portfolio manager at Hazelview Investments told Wealth Professional.
As a rule, REITs perform well in high-inflation environments because of their ability to capture rising prices through annual contractual rent bumps embedded in real estate leases. But the sector was severely tested by last year’s change in monetary policy, especially given the swiftness of the increase in interest rates, along with pervasive fears of a consequent recession.
“The significant hawkish change in monetary policy around the world caused multiples to compress among REITs,” Sahn says. “Higher interest rates really influenced every part of the global economy. It influenced currency markets, mortgage rates, and bond prices. And the change in the cost of capital had a big impact on REITs as well.”
REITs also tumbled on technical factors in 2022. Aside from selling pressure fuelled by investor redemptions, investor positioning issues and style preferences – at one point, surging commodity prices made energy a more exciting space to be in than real estate – took their toll. Putting all those circumstances together, Sahn says 2022 will be remembered as “the worst calendar year in over 30 years, second only to 2008.”
“While future changes in interest rates are out of our control, we believe the stabilization in the cost of capital will provide the market with the clarity needed to better triangulate what real estate values will be going forward,” Sahn says.
As the dust settles, Hazelview believes REITs with best-in-class real estate portfolios that generate superior earnings growth, which are run by cycle-tested management teams, will separate themselves from the pack over the next couple of months.
“We think a lot of what REITs endured over the course of 2022 will revert to the mean in 2023, so that the underperformers are going to become outperformers,” Sahn says.
For investors focused on the real estate investment space, Sahn says the key to success this year will be stock selection – finding REITs that can perform regardless of what happens in the broader market. That means identifying REITs that are undertaking company-specific initiatives to realize their embedded valuation.
Globally, Hazelview believes there are attractive opportunities in Asia, particularly Hong Kong, as travel restrictions and COVID-zero policies are quickly relaxed. One company on their radar, Swire Properties, stands out for its ESG policy and low-leverage balance sheet, which Sahn says is among the best in the realm of publicly traded real estate.
“Between Hong Kong and China reopening and business in the city getting back to normal, we think the stock is overly discounted today, and has significant share price appreciation over the next 12 months,” he says.
An Australian company, Mirvac Properties, has also caught Hazelview’s interest. A recovery of international migration from China, coupled with continually declining vacancy rates and rising prices and rental rates, sets up its residential business for improvement over the next 12 months. Its office exposures, particularly in Melbourne and Sydney, are also well-placed for upward rental revisions over the next few quarters.
Closer to home, the industrial sector in the U.S. is still seeing robust demand for industrial properties, particularly as last-mile properties near customers for same-day delivery stays strong. Sahn says Rexford Industrial Realty, with “one of the best portfolios in the entire market,” could have what it takes to deliver outsized earnings growth and, consequently, strong NAV growth and dividend growth in 2023.
“We’re also partial to the technology sector, particularly cell towers,” he adds, noting how a non-cyclical shift from 4G to 5G mobile usage is driving considerable demand for that new breed of infrastructure among wireless networks. “We feel there’s a way for these companies to capture inflation through contractual rent bumps that other asset classes will not be able to experience.”
