The year just gone was no more pleasant for global real estate investors than for those in any other sector. In terms of returns it was the worst year for the asset class since 2008, losing more than 24 per cent.
The macro context of 2022 is well understood, and the sensitivity of the real estate sector to rate moves is not surprising.
Over the course of 2022, the yield on the US 10-Year Treasury rose 243 basis points and this has driven much of the pain in real estate markets.
In terms of sectors, there was really nowhere to hide, with all areas of the market posting negative returns. Offices and residential were the hardest hit as markets queried fundamentals as well as the macro environment.
Learning from history
Entering 2023, there clearly remains a broadly uncertain macro-economic environment with major global economies in or likely to enter recession, and inflation putting pressure on policymakers and consumers alike.
So, what does this mean for investors in the listed real estate market?
History has some interesting lessons here, with the maturity of the listed real estate market (active since the 1960’s) enabling performance analysis during similar economic conditions to the ones we find ourselves in.
Research from Nareit (the North American Real Estate Investment Trust Association) shows that on average during the last six recessions, REITs have outperformed equities.
While REITs have typically underperformed private real estate before recessions, as happened in 2022, they have outperformed private real estate during and after recessions.
The reality of private markets lagging public markets is one that creates an opportunity for investors considering allocating to listed real estate at the start of 2023.
The consistent challenges around liquidity and gating for the UK direct property funds is another factor that could drive investors away from private real estate, and towards the listed real estate market.
Identifying bright spots
On a fundamental basis, there are three core drivers of real estate performance looking ahead that investors should be considering as they look to deploy capital.
First, in a recessionary environment, quality of earnings (rather than lofty growth expectations) is an important focus area. Many REIT sub-sectors can offer investor exposure to high-credit tenants providing mission-critical assets for their tenants.
Healthcare and communications real estate are two good examples here, and the strength of dividend distributions provides evidence of underlying health.
As a component of total return, dividends can play a particularly important role during a recessionary environment. This consideration also highlights continued challenges facing more traditional sectors such as offices and retail, where the recalibration of working practices post-Covid is sustaining uncertainty.
Investors need to remain highly selective in the sorts of underlying assets they seek exposure to in these areas.
Second, balance sheet strength and access to capital is increasingly important. The era of free money is over, and REITs with conservative balance sheets and good access to capital will be able to out-grow their competitors.
