11 February 2024
If you are covering REITs, please find commentary below from Oli Creasey, property research analyst at Quilter cheviot:
"The property sector has had a tough couple of years, with values falling fast, then slow. However, that is no promise that values now have to rebound. Our expectation is that REIT shares have largely priced in near term rate expectations, and there is limited upside available as a result. That doesn’t mean serious negative returns are necessarily in prospect, but that the sector may struggle to make equity-like returns.
"It is now widely assumed that Central Banks will be cutting rates sooner rather than later. However, it looks as though these cuts are fully priced in. We attribute the +25% move in Q4 2023 to the market coming to terms with peak rates and the path set out for rate cuts in 2024. Our view is that property valuers will not follow rates as quickly or as fully as they did the rate rises of 2022.
"Valuers approached property appraisals in 2022 with a metaphorical axe, before switching to a chisel in 2023 to refine valuations. We project that the valuation teams will continue to make small adjustments to values in 2024. In our view, the property market has been overly obsessed with interest rates in recent years, which has served to obscure more structural issues in some sectors. The office market has been disrupted by the relatively recent working from home trend, while retail property has been hurt by inflation and the impact on consumer spending. The industrial market is not immune to those inflationary effects, although it has other structural drivers that mitigate the impact.
"We are still assuming that rate cuts do materialise, on schedule. However, valuers may not be so quick to act once they do start to fall. Our concern is that the initial rate cuts will be used by the industry to rebuild a risk premium, which has compressed as rates have risen, rather than being passed through to lower property yields. Property investors may have to wait a little longer for capital growth to return.
"Property values moved sharply in 2022 as valuers were compelled to reflect new rate expectations in their assumptions. The big question is whether valuers move as quickly on the way back up? We think not. With limited transactional evidence, and a preference for a cautious approach to valuations in the absence of such evidence, we don’t expect valuers to react immediately to rate cuts.
"Our central assumption for property in 2024 is values essentially flat, and property returns derived almost entirely from income. There will be differing outcomes for each sector – we still believe industrial is structurally sound, particularly near urban centres. Unlike 2023, REITs are not starting from a low base. NAVs have fallen over the past twelve months, while share prices have increased (although not that much in absolute terms). Globally, REITs are trading at around a -4% discount to the long-term average NAV discount – on the right side of the line, but not materially so. While we’d expect REITs to outperform direct property, the sector is less likely to outperform the wider equity market."
