In an effort to arrest high levels of inflation, central bankers aggressively increased interest rates by some 500 basis points beginning in May 2022. As a result, inflation has declined significantly from its highs and 10-year government bond yields are down by 80 to 100 basis points over the past few months. We are now expecting cuts in overnight interest rates throughout 2024.
What does this mean for REITs?
For the past two years, despite solid fundamentals in many real estate sectors (i.e., vacancy rates below 2% in industrial and multi-family and significant re-leasing spreads in retail), REIT stock prices have lagged. Investor sentiment for the broader real estate sector has been disaffected by the rise in interest rates, high vacancies in the office property sector as well as high yields available in cash or near-cash alternatives, such as GICs & HISAs.
With bond yields declining and central bankers looking to cut rates later this year, we believe REITs are extremely well-positioned to outperform. The opportunity cost of owning cash relative to other asset classes is rising and cash returns are declining as investors are required to reinvest at lower yields. Quality REITs that generate stable and growing cash flows offer far better total return potential and can still be purchased at a significant discount to NAV.
Rate Cuts, M&A and Fundamentals will Drive a Rally in 2024
The last time there was a dislocation this large between REIT asset values and their trading prices was the Global Financial Crisis. Unlike the GFC, however, real estate balance sheets and liquidity ratios are in much better shape and the high cost of construction is a major impediment to adding new supply. In addition, we’re witnessing a return of major M&A transactions which are validating our NAV estimates and driving a healthy recycling of capital in the real estate sector. Specifically, TPG invested $1 billion in a portfolio of GTA industrial properties in December 2023, while Blackstone announced the $3.5 billion acquisition of Tricon Residential at a 30% premium to its previous trading price in January 2024. In light of the current economic backdrop, we expect continued M&A in North American real estate markets throughout 2024.
How Should Investors Capitalize on this Opportunity?
As active managers, our team can skate where the puck is going by focusing on the most attractive sectors of the real estate market and the companies that can consistently create value for shareholders. Middlefield is among the longest standing and top real estate managers in Canada. As a result of our focus on downside protection and portfolio discipline, supplemented by our experience, knowledge and relationships in the real estate sector, we have successfully avoided the major underperformers while owning the highest quality issuers.
Middlefield’s Real Estate Dividend Fund was awarded the Lipper’s Best Fund over 5 years – Real Estate Equity for 2021 and 2022. This mutual fund has a 5-star Morningstar rating and is first quartile in the Morningstar peer group over the 1, 3, 5 and 10 year periods as of December 31, 2023. Furthermore, the Middlefield Real Estate Dividend ETF just received an A+ rating for 2023.