Macro Stabilization to Benefit Real Estate
PGIM Real Estate’s Rick Romano sees optimism for public REITs with rare buying opportunities as macro visibility improves and private asset values decline.
Reits Revive as Valuation Gap continues to narrow
Dec 9, 2022
PGIM Real Estate's Rick Romano, CFA, discusses how REIT fundamentals are resilient through near-term uncertainty and offer upside potential as macro visibility improves.
MACRO CLOUD COVER
While the backdrop warrants continued caution, performance among public real estate securities appears to show that investors may be focusing on macro risks to a degree that underappreciates a particularly compelling situation. But, REIT fundamentals remain resilient at a time when REITs should stand out due to their inflation-hedging characteristics and limited supply chain exposure. Not only do REITs offer traits that can serve investors well in current conditions, but they also represent opportunities that should be hard to ignore as visibility improves due to a historically notable disconnect between REIT prices and the private market value of the real estate they hold.
As capital markets stabilize, we expect to see private capital flow into public markets toward a menu of opportunities available at attractive price levels.
THE RIGHT KIND OF SHELTER
As for current conditions, REITs that benefit from defensive demand should stand out for their ability to maintain or grow revenue as central bank tightening efforts take their toll on the broader economy. Properties that serve need-based demand, including health care facilities and multifamily apartments, are attractive because the underlying trends are driven by demographics and market dynamics rather than the economic backdrop.
REITs that offer limited exposure to inflation are appealing given persistent price pressures in the economy. Self-storage facilities are in that group because their reduced need for labor limits their exposure to wage inflation. Properties with triple-net leases also offer an inflation hedge because landlords can pass along most higher costs to tenants. Should signs emerge that inflation is easing, properties with significant staffing needs, such as assisted living facilities and hotels, will become increasingly appealing.
UNDERVALUED OPPORTUNITIES
Market volatility leaves REITs looking overshot to the downside relative to value of real estate assets they hold, creating an attractive arbitrage opportunity. The situation is likely spur M&A activity, with U.S.-based buyers positioned to bargain hunt via cross-border transactions due to the strength of the dollar. Having been swept up in the volatility of 2022, REITs trade at a significant discount to their NAVs. When REITs traded at discounts to their NAVs of 10% or more over the past 25 years, they subsequently delivered three-year returns relative to private real estate that ranged from 25% to more than 50%.
Rick Romano, CFA
Head of Global Real Estate Securities
PGIM Real Estate
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