Fund managers globally have been left battered and bruised by the triple storm that swept across the economic landscape this year.
After an extended period of zero inflation, low interest rates and all-time highs registered by the major U.S. stock markets, 2022 saw a pronounced reversal of fortune in all three of those financial indicators.
Inflation soared to 40-year highs, Fed chairman Jerome Powell channelled the ghosts of Milton Friedman and Paul Volcker, and the S&P 500 average fell from record highs to close down nearly 17 per cent on the year as of Dec. 15.
Global real estate investment trusts (REITs) have been one of the major casualties of the sharp market downturn, recording their second-worst performance since the beginning of the REIT era in 1991.
However, according to Hazelview Investments’ 2023 Global Public Real Estate Outlook Report, released Wednesday, the future is looking much brighter for REITS as we head into a new year that should see inflation continue its current downward trajectory and a corresponding easing of Fed policy.
Setting the stage for a recovery
"Fundamentals went out the door in 2022 as markets focused on high inflation and hawkish monetary policy," said Corrado Russo, senior managing director, investments and head of public real estate investments, in an interview with RENX.
"And, while this can be frustrating for us as active managers, we know this can present exceptional opportunities in 2023 which we believe will be more about weaker growth, moderating inflation and an end to rate hikes or a partial reversal.
"The best long-term returns are generated when buying at discounts to intrinsic value and investor sentiment is at its lowest, both of which are true today."
But, a near-record bad year sets the stage for investors to take advantage of an oversold REIT sector that suffered from fears rapidly rising interest rates might trigger a recession in 2023.
The Hazelview study argues that as things turned out, the markets were overly pessimistic, particularly with respect to REITs.
"All of those concerns are valid to a certain degree, but we just think the magnitude to which they’ve been priced-in this year is overly aggressive," said Russo. "For some sectors it’s more warranted, for other sectors it’s less warranted."
Upheaval in the commercial property sector
REITS are now trading at historically severe discounts as investors have been racing to cash out from real estate funds, a key indication high interest rates and economic uncertainty have created upheaval within the commercial property sector.
The Hazelview report drew attention to the over $18 billion in outflows from REIT mutual funds and ETFs over the course of 2022, attributable to increasingly pessimistic investor sentiment that turned even more negative than during the depths of the 2008 global financial crisis.
As of early December, the FTSE NAREIT All Equity REITs Index, which tracks publicly traded landlords, was down more than 20 per cent this year, and commercial real estate owner REITS are off nearly 30 per cent year-to-date.
A Dec. 6 article in The Wall Street Journal reported the redemption frenzy had reached the point that the two largest non-traded REITs, Blackstone and Starwood funds, were forced to take measures to stem the massive capital outflows.
The story revealed that Blackstone Inc. has imposed limits on investor withdrawals from its $69 billion flagship real estate fund "following a surge in redemption requests" and Starwood Capital Group had also advised investors it was "restricting withdrawals" on its $14.6 billion fund.
Q4 REITS rebound sign of reversion to norm?
The Hazelview study offers reason for optimism, however, believing that economic indicators are trending positive for 2023.
"Despite all that went wrong, REITs rallied in Q4 2022 gaining 8.5 per cent (through Dec. 6), driven by the first signs that the pace of inflation is potentially slowing (like in the U.S.) and central banks are possibly open to moderating the pace of future interest rate increases (like in Canada and Australia), which would relieve some pressure on equity prices," the report states.
Uncertainty is kryptonite to markets and particularly virulent with respect to REIT investors.
In recent weeks, the U.S. has reported unexpectedly robust 2.9 per cent growth in third-quarter GDP as well as the third consecutive monthly decline in year-over-year inflation to 7.1 per cent for November.
Should these figures continue to trend in the right direction, investor confidence is bound to grow in anticipation of stable or declining interest rates.
"It’s the anticipation of rate hikes that hurts REITs most. With uncertainty around the cost of borrowing, it is very difficult for markets to assess the value of the underlying real estate owned by REITs," said Samuel Sahn, Hazelview portfolio manager, public real estate investments.
"Rates hikes don’t necessarily even need to reverse to shift the valuation paradigm - they just need to moderate or stop going up and be more predictable."
Sahn, who oversees Hazelview's vast real estate holdings from his office in New York City, takes the view that if past history is any guide, the REIT sector should enjoy a healthy rebound in 2023.
"If we look back at 1990, 1992, 1994, and 2008, the only years where REITs experienced double-digit declines, we've seen the sector bounce back strongly the following year in every case," said Sahn.
"As we look at the next 12 months, we think that REIT earnings are going to exceed dampened expectations, which will be a positive catalyst for share prices.
"We think mergers and acquisitions could serve to set a floor for stock prices next year. And we think the macro environment becomes a bit more favorable for the asset class overall relative to what we saw this year."
Canadian REITs offer strong prospects for growth
Just as U.S. REIT valuations have cratered in 2022, their Canadian equivalents are also trading at a steep discount.
According to the FTSE EPRA/NAREIT Canada Index, REITs in Canada were down 21 per cent versus a year ago as of Dec. 14. For Sahn, this represents a buying opportunity.
"We think valuations in Canada are attractive, and, similar to the world, Canadian REITs are currently trading at sale prices," said Sahn.
"We are finding the best opportunities in the multifamily and the industrial sectors in Canada. The growth prospects with respect to multifamily business is attractive. Occupancies are high and will continue to remain high.
"Favourable immigration policy leads to new workers coming to the environment, which is going to result in a greater demand for housing and affordable housing while apartment rents continue to increase steadily based on each province's] rules and regulations.
"There's also a significant opportunity within the industrial sector. Market rents continue to rise because there's a lack of viable land available for new supply to enter the market.
"We think market rents will continue to increase at a healthy clip that outpaces inflation and that valuations will remain strong.
"So those are two property types within the Canadian landscape that we have a favourable view on, and where we are positioning our portfolios for 2023."
Hazelview looks to outperform, targets worst-hit companies
Looking ahead to 2023, Hazelview believes it will be able to outperform the market by targeting companies whose share prices have been overly depressed and thereby stand the best chance of beating index averages.
"Cheaper valuations due to this year’s poor performance is a big part of the REIT story entering 2023," Russo said.
"We believe, through active management, we can position our portfolios to take advantage of the downdraft in share prices this year and aim to concentrate our portfolios in companies that trade at larger discounts than the overall market."
In keeping with this bullish outlook, the Hazelview report also contained the following rallying call: "Today’s losers are positioned to be next year’s winners."