Real Estate Investment Trust (REIT) prices are gradually rallying, following over reaction to an outward shift in property valuation yields in response to capital market challenges, which led to discounts to net asset value (NAV) of more than 40% last October.
The REIT market starts 2023 at an historically attractive discount of 35.4% versus a 20-year average discount of 15.0%.
Matthew Norris, investment adviser at Gravis, adviser to the VT Gravis UK Listed Property (PAIF) fund says the degree to which property values move is likely to be determined by the ability to capture continued rent growth. Valuations for best-in-class assets within subsectors, such as logistics and build-to-rent, are likely to stabilise in the first half of the year as continued rent growth, high occupancy, and low tenant turnover drive strong cashflow performance.
“However,” Norris says, “with monetary policy continuing to be actively used to tame ongoing inflation the cost of corporate debt, including for REITs, is rising and will offset some of the benefits of growing rents.
“Increasing interest rates have led markets to grow fearful of a recession, albeit a shallow one, and together with the increasing need to respond to climate change, the biggest of all risks, owners of physical real estate are likely to accelerate the flight to quality in 2023.”
While more cyclical assets, especially secondary office assets in secondary location, are likely to be negatively impacted in a recessionary environment by contrast, prime real estate assets, especially those with strong ESG credentials, generally owned by specialist REITs, are likely to continue to experience the highest levels of demand from occupiers and outperform.
Stock picking, Norris says, remains key.
“As we move closer to the end of the compliance window for commercial property adhering to the Minimum Energy Efficiency Standards (MEES) of an Energy Performance Certificate (EPC) level C in 2027, increasing to level B in 2030, there is likely to be an acceleration in the flight to higher quality assets.
“As is often the case in both rising and falling markets, there is a tendency to overshoot; and that is certainly impression as we start the new year. Good quality REITs with market leading assets currently look over sold. The year ahead looks likely to benefit from the tailwinds of rental growth, supported by favourable demographic trends and structural changes which will likely offset the capital markets headwind.
“We expect continued rental growth and, in turn, dividend growth. A scenario which would once again prove that investing in the right thematic real assets can provide investors with growth income and not fixed income.”