What comes after the great REIT-opening?

If ever there was a year to show investors just how resilient commercial real estate can be as an asset class, 2021 would be a very good contender.

In its latest 2022 Global REIT Outlook report, Hazelview Investments noted that global REITs managed to advance 24.7% for 2021 through December 6, recovering handily from the battering they had suffered amid lockdowns in 2020. The REIT-opening was led by the Canadian and North American markets, which rose by some 35% and 30%, respectively, much higher than Europe and Asia.

“I think it had a lot to do with the pace of the reopening of their economies,” says Corrado Russo, head of Global Public Real Estate Investments at Hazelview. At the beginning of the year, the U.S. led the way in terms of vaccinations; Canada was a few months behind, but the take-up rate was much faster, so it was able to catch up. That restored mobility in North America sooner, which released pent-up demand for things that were taken away from us during COVID.”

Consumers were able to effectively unleash that demand largely because of the fiscal and monetary stimulus governments extended to individuals and businesses. But while economic supports were extended across the world, the relatively quick shift toward a “living with COVID” mentality in North America made it a bright spot.

“We very quickly got to asking ‘How do we get on with our lives and adopt a balance between addressing COVID, but also getting the economy going?’” Russo said. “That’s compared to what we saw in Asia, and to a certain degree Europe as well, where they expressed a zero-COVID mentality by imposing lockdowns and hard restrictions until cases get to zero and stay at zero.”

REITs have also been getting a lift from investors searching for tools against surging inflation. As Russo explained, the real estate segments that offer the best inflation benefit tend to be the ones with shorter lease durations, which allow property owners to mark rents to market more quickly as their contracts roll over. The ability to pass higher costs on to tenants through pricing power, as well as disequilibrium between supply and demand for real estate assets, are also key.

One area that ticks all those boxes has been industrial real estate where property owners have seen a substantial surge in pricing power. With the gale-force intensity tailwinds currently supporting e-commerce demand, Russo says the competition for commercial storage properties is getting very ugly, very quickly.

“You have demand for just-in-time delivery and the last-mile demands to get product to customers as quickly as possible. At the same time, online merchants have specific needs in terms of floor loads, ceiling heights, and turning radius,” he says. “Industrial product is becoming obsolete just as demand is surging, and we're seeing rents go up because of that.”

The multifamily residential has also been strong. In Canada, robust demand is clashing with short-duration leases, where a new tenant starts with a one-year contract then goes month-to-month. The U.S., meanwhile, is seeing a lot of individuals heading back to the urban downtowns of New York, San Francisco, L.A., and the like, which is reinflating demand and pushing down vacancy rates.

“In Canada as well, I think we’ll continue to see higher demand for multi-family and apartments,” Russo says. “A big part of the government’s growth plan to get us out of the COVID deficit we’ve built is to increase immigration, which raises the outlook for housing demand in major cities.”

Looking at recent inflation reads, the ability for existing asset values to go up along with replacement costs, and property owners’ ability to pass along costs to tenants, Russo says the fundamentals for commercial real estate are positive and appear healthy enough to carry into 2022. Those conditions set the stage for steady earnings growth and, consequently, appreciation in prices of stocks. Growth in earnings can also help REITs outperform in rising-rate environments – but there’s an asterisk to that.

“The biggest thing to keep an eye on, frankly, is what’s going to be central banks’ and governments’ reaction to inflation,” Russo says. “Monetary and fiscal stimulus is going to come off at some point, and I don't think that should surprise the market or anyone. But if you pull the rug out from under the economy, you could destabilize things the economy could take a step back.”

Central bankers have projected confidence by asserting that inflation is temporary, though recent CPI prints from both sides of the 49th parallel suggest that the rising price of everything is here to stay. That means policymakers now have the unenviable task of easing back on stimulus to avoid economic overheating, but not so much that it causes the engine to stall.

Already, central banks are signalling a hawkish turn as they drop hints on how they intend to taper their bond purchases and hike interest rates. For many hard-hit consumers, investors, and business owners, that withdrawal of support will be akin to rubbing salt in a still-fresh wound. But from a broader, more bullish perspective, it shouldn’t be a cause for concern.

“If you want take the view that COVID restrictions artificially removed demand from the economy, fiscal and monetary stimulus were put in place to keep things relatively in check,” Russo says. “It makes sense that as the economy improves and natural demand comes back, you’d take off the artificial demand.”