Is it the right time to invest in property funds?

Real estate investment trusts, or Reits, are now showing signs of a potential comeback but analysts recommend exercising prudence

Reits invest in commercial property such as office blocks, warehouses, shopping centres, industrial parks, supermarkets, hotels, resorts and elderly care homes. Getty Images

One of the worst-performing investment sectors of the past three years looks ripe for a comeback and may tempt investors looking for high income and capital growth, provided they aren’t afraid of taking a risk or two.

After crashing in 2022 and struggling since, real estate investment trusts (Reits) now look cheap, oversold and offer a stellar rate of income with yields of up to 8 per cent a year.

Industry experts predict that Reits will regain popularity when interest rates decline, and sentiment picks up. So have you got the Reit stuff?

Investment portfolio

Reits invest in commercial property such as office blocks, warehouses, shopping centres, industrial parks, supermarkets, hotels, resorts and elderly care homes. This allows investors to diversify their portfolios beyond residential real estate.

They offer a combination of rental income from tenants and capital gains from property sales, and can be tax-efficient, too.

Reits usually do not pay corporate taxes, provided they distribute at least 90 per cent of their income to shareholders as dividends (which the investor may pay tax on). This makes Reits the vehicle of choice for property investment companies in the US, Europe, Middle East and beyond.

However, recent market conditions have posed challenges for Reit investors. The sector has been significantly impacted by a variety of social and economic trends.

The pandemic-induced lockdowns severely affected shopping centres, supermarkets, and hotels, while the shift to remote work has diminished the demand for office space.

Furthermore, the surge in interest rates has provided investors with high yields from cash and bonds, offering a lower-risk alternative to Reit investments. In 2022, the FTSE Nareit All Equity Reits Index experienced a significant decline of 24.9 per cent, reflecting the challenges faced by the sector.

The warehousing and logistics sector emerged relatively unscathed, benefiting from the increased demand in e-commerce and the surge in deliveries during lockdowns.

Currently, there are promising signs of recovery in the real estate market. The Nareit has climbed 11.36 per cent over the past 12 months, indicating stabilisation in property prices and a rebound in rents.

Right time to get in?

Reits are still undervalued, trading at a discount of about 24 per cent to their underlying net asset value, according to the Association of Investment Companies. This has led to a sense of optimism within the industry.

“The only way is up,” says Richard Shepherd-Cross, managing director at Custodian Property Income Reit. “Vacancy rates are falling, and rents are growing within all sectors, including well-located, higher-spec offices”.

There is a wall of money waiting to invest in the sector, he says. “Every time macro news suggests a higher probability of a rate cut, shares rally. When the odds diminish, they fall. The market is literally twitching with anticipation and prices could ramp up significantly once we have more clarity.”

Tony Hallside, chief executive at STP Partners in Dubai, is also upbeat. “There are signs the sector might be ready for a rebound as pressures start to ease.”

Many Reits maintain strong fundamentals, favourable supply-and-demand dynamics and solid balance sheets, Mr Hallside says. “The retail sector, for instance, has found opportunities as shopping centres adapt to changing consumer preferences.”

While the office market remains uncertain, other Reit sub-sectors, like manufactured housing, have shown resilience and potential for long-term growth, Mr Hallside adds. “Reits may offer attractive opportunities for income and diversification, for those willing to endure short-term volatility.”

Not every real estate market was hit by the pandemic and inflation shock, Dubai was a notable exception, says Zain Qureshi, global head of real estate finance and advisory at Mashreq Bank. “It has seen an influx of office occupiers and the market is now experiencing a shortage of quality space.”

The performance of Reits is heavily influenced by local market conditions, making thorough research essential for investors, analysts say.

“Performance has a lot to do with the underlying cost of doing business locally which affects performance metrics such as yields or share price,” Mr Qureshi adds.

Andrew Rees, investment trust research associate at Deutsche Numis, recommends targeting sectors with healthy rental growth, as this will drive the bulk of the returns over time. “Right now, those are most likely to be the private rented sector and industrial and logistics.”

Don’t just grab the highest dividend you can find but look for a track record of maintaining and increasing payouts, and check whether the yield is covered by earnings, Mr Rees says. “If not, the trust may be dipping into capital to maintain dividend payments. That is unlikely to be sustainable in the long run.”

Understand risk exposure

Reits are not out of the woods yet, though. Last month, the US-based Starwood Capital Group capped investor withdrawals following a rush of redemptions from its $10 billion Reit.

Vijay Valecha, chief investment officer at Century Financial, says the decision “is causing significant stress amongst top investors”.

“The fund, which invests in industrial, office and multi-family properties, is bleeding cash as management awaits US interest rate cuts. It’s a stark reminder of the risks.”

Until the US Federal Reserve starts cutting rates, many will prefer to play safe with cash, bonds and money market funds. “For Reits to pick up, US interest rates have to go down.”

However, the greatest gains are typically experienced by those who invest before the recovery begins, rather than after. Therefore, individuals who are willing to take on risk may consider seizing this opportunity today.

Mr Valecha notes that shares in US Reit Iron Mountain, which specialises in data centres, art storage and logistics, have climbed 24 per cent so far in 2024. Another Reit, National Health Investor, has rallied 21 per cent.

He favours the US-based Omega Healthcare Investors, which has $9.11 billion of assets and an indicated yield of 8.23 per cent. Its first quarter revenue jumped almost 10 per cent to $243.3 million.

Mr Valecha also highlights Apple Hospitality, which invests in hotels, guest rooms and resorts, and recently reported a 6 per cent rise in first quarter adjusted earnings to $101 million. “Its proposed acquisition of AC Hotel Washington bodes well. The trust yields 6.67 per cent.”

Another US Reit, National Storage Affiliates, yields 5.92 per cent from a portfolio of self-storage facilities.

The European Central Bank has recently initiated interest rate cuts, a move that is expected to enhance returns on European Reits. However, Mr Valecha advises investors to exercise caution when considering investment opportunities in this asset class.

“The ECB actually hiked its inflation forecast until 2025, so rates could stay higher for longer. Risk exposure is higher than the US.”

He nonetheless likes French Reit Gecina, which has €20 billion ($21.4 billion) of property around Paris and yields 5.48 per cent, and Belgium-based Aedifica, which specialises in elderly care homes and senior housing, and is forecast to yield 6.53 per cent.

Paul Simmons, co-founder of UK real estate firm Greenridge Investment Management, says there is a window of opportunity to lock into today's asset values before the property market enters a new cycle. “Investors should move promptly and with expert advice to capitalise on opportunities.”

Now is an opportune time to consider investing in Reits as a component of a diversified portfolio. However, it may be prudent to exercise patience and monitor interest rates before making any decisions.