History says REITs now due for strong uplift: American Century

New commentary from global asset manager, American Century Investments, has suggested that the historical track record of real estate investment trusts (REITs) indicates there is the strong possibility of an “upswing” in returns this year, despite current low valuations.

Steven Rodriguez, Vice President and Portfolio Manager at American Century, said a lack of supply, particularly in senior housing development, has seen valuations reduce but also paves the way for a stronger rebound.

“Listed REITs valuations are trading today at some of the widest discounts that we have seen relative to the S&P 500 for several decades. The last time valuations traded this cheap, we saw strong relative and absolute returns for the REIT sector,” he said.

“The strongest tailwind today for REITs is a lack of supply. Given the very high interest rates we’ve had in recent years, we’ve seen very little new development because of high capital costs.

“As a result, over the next 12 months we expect to see a dramatic fall in new development completions, which means greater pricing and earnings power for a large majority of the REIT universe.

“The elevated interest rates that troubled REITs are now helping fundamentals. That’s because higher interest rates, which increased the cost of accessing capital, slowed new real estate development over the last three years.

“The result is a favourable supply-and-demand dynamic for most existing operating assets.”

According to Rodriguez, approximately four-fifths of American Century’s REIT space is experiencing its lowest rate of supply growth in the last five years, with single-family housing and data centres – due to trending artificial intelligence (AI) thematics – emerging unscathed.

“We feel most bullish about senior housing estate in the current supply-demand environment,” he said.

“From a demand perspective, we have about 11,000 people in the US turning 65 years old each day. However, when you compare that to supply, you only get 25,000 to 30,000 new units of development completions annually for seniors housing, so that is a very big imbalance between demand versus supply.

“As a result, pricing power is very high, and therefore, the earnings power of REITs involved in seniors housing is increasing.”

Rodriguez also signalled expectations that both inflation and interest rates in the US would continue on its current trajectory toward the Federal Reserve’s target range, thus posing no risk for REITs.

He also identified several opportunities in the Australian REITs market that could capitalise on attractive valuations and the potential for declining interest rates, including Scentre Group, Stockland, Mirvac Group and Charter Hall Group

“We see anchors of inflation moving forward, including shelter inflation. We see shelter inflation still has a lot more room to fall providing downside pressure to inflation. We see that as acting as an anchor to overall inflation,” Rodriguez said.

“Moreover, listed REITs have dramatically outperformed private property in the last few years, which is the result of high leverage in the private real estate industry. Listed property also offers greater transparency and they have better balance sheets.”