PGIM Quantitative Solutions’ 4Q 2021 Outlook: Stay the Course for Now
PGIM Quantitative Solutions explains why despite a few speed bumps, moderate pro-risk positioning remains supported by a robust global recovery.
The COVID-19 pandemic severely challenged the global real estate industry over the past year. First, it virtually shut down office culture, socialization, and travel. Then, as the world recovered, the industry was transformed. With different parts of the world experiencing their own distinct stages of recovery, three distinct trends—reopening, reflation, and recalibration—are driving compelling opportunities for real estate investors.
Uncertainty during the pandemic was damaging to select real estate sectors, causing the entire industry to underperform the broader equity market in 2020. However, several real estate asset classes maintained resilient income levels throughout the crisis and are continuing to show growth as market conditions improve. Unlike the Global Financial Crisis in 2008-2009, real estate investment trusts (REITs) entered the pandemic with relatively strong balance sheets and did not need to recapitalize at distressed share prices. As economies reopen and uncertainty gives way to optimism, hard-hit sectors should recover as business operations return to normal. In PGIM Real Estate’s view share prices are expected to bounce back strongly in the following sectors:
The enormous stimulus packages that governments and central banks rolled out during the pandemic helped markets recover and economic growth rebound, but they have also driven up prices. As these initiatives continue to place inflationary pressures on both wages and hard assets, real estate price appreciation may not be far behind. Historically, real estate has demonstrated strong correlation with inflation, particularly in assets with short-lease duration and strong operating leverage. Lease renewal and Consumer Price Index (CPI) provisions in longer leases provide a natural hedge to rising inflation. However, shorter-lease duration assets tend to appreciate the most when reflation takes hold, particularly those seeing strong demand, which allows lease holders to pass expenses along to their tenants.
Investors seeking inflation protection should consider residential properties. These asset classes are poised to benefit from reflation, as improving cost controls and supply/demand imbalances should lead to above-CPI operating income growth. Areas that are particularly attractive include:
Technology has enabled some REITs taking advantage of their scale and operating history to incorporate vast volumes of data into various aspects of their business. What will follow is a period of consolidation as some REITs acquire small to mid-sized trusts to realize value through gains in efficiency. This merger-and-acquisition trend is only just beginning and is expected to continue for months, or even years. One example is Prologis, a logistics company that tracks every leasing decision made across 450 million square feet of real estate in the U.S. Prologis compares this data to internal forecasts and uses it to guide future underwriting assumptions, resulting in more accurate forecasts. Welltower, a large-cap healthcare REIT, is also embracing this trend by incorporating data it acquired from 20 years of operating senior housing. In Welltower’s case, decades of experience have translated into an abundance of proprietary data, allowing it to segment the U.S. into 8.2 million micro-markets and identify the optimal portfolio for net operating income growth over the next decade. Investors have recognized the importance of certain REITs’ platform and scale and have assigned them premium valuations. These valuations have subsequently lowered REITs’ cost of capital, allowing them to acquire real estate portfolios and other less sophisticated REITs that add to earnings.
Identifying the REITs best positioned to benefit from reopening, reflation, and reconstitution requires careful research and a deep understanding of the global real estate market. Investors seeking to gain exposure to these trends should consider an active real estate manager with deep knowledge and experience in real estate securities. PGIM Real Estate has extensive experience in public and private real estate markets. With more than 500 investment professionals in 32 offices across the globe, PGIM Real Estate offers the resources needed to identify the most attractive investment opportunities in today’s market.
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1 PGIM Real Estate estimate as of June 15, 2021.
2 SQM Research as of June 1, 2021.
Certain information in this commentary has been obtained from sources believed to be reliable as of the date presented; however, we cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. The information contained herein is current as of the date of issuance (or such earlier date as referenced herein) and is subject to change without notice. The manager has no obligation to update any or all such information, nor do we make any express or implied warranties or representations as to the completeness or accuracy. Any projections or forecasts presented herein are subject to change without notice. Actual data will vary and may not be reflected here. Projections and forecasts are subject to high levels of uncertainty. Accordingly, any projections or forecasts should be viewed as merely representative of a broad range of possible outcomes. Projections or forecasts are estimated, based on assumptions, subject to significant revision, and may change materially as economic and market conditions change.
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1049904-00001-00 Ed: 07/2021