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PGIM Real Estate 4Q 2019 Outlook card
Real Assets

Re-opening, Reflation and Re-calibration Continue to Provide Tailwinds Re-opening,ReflationandRe-calibrationContinuetoProvideTailwinds

Nov 9, 2021

PGIM Real Estate shares its views on the current economic environment and outlook for global real estate securities.

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Global REITs took a bit of a pause in the third quarter of 2021 as returns were essentially flat following strong gains in the first half of the year. We believe REITs continue to benefit from the 3 R’s: reopening, reflation and recalibration. And we expect these tailwinds to persist for the next few years.   

At a glance – PGIM Real Estate’s regional market views as of July 2021

Region  Market Review & Outlook  
U.S. 

 

 

After a very strong first half of 2021, the U.S. REIT market was essentially unchanged in the third quarter of 2021, up just 50 basis points.

 

The highly contagious Delta variant of the COVID-19 virus hit the United States with force in the quarter, with daily cases surging back to the 150,000 range. Despite that recent Delta-driven surge in COVID-19 infections, most U.S. consumers have not significantly altered their economic patterns. Foot traffic remains high in both malls and shopping centers; occupancy continues to recover in all residential sectors; and the industrial and storage sectors continue to push through aggressive rental rate increases. The U.S. REIT market remains attractive given reasonable valuations, ability to participate in the economic reopening of the country, and strong inflation protection for investors. Thus far in 2021, U.S. REITs are up 21.8% versus 15.9% for the S&P 500 Index. 

 

The best-performing sectors during the quarter were apartments and specialty housing (single-family rental and manufactured housing). Apartment REITs are seeing occupancy rebound significantly, which leads to increased pricing power and concession elimination. In some markets, rents are well above pre-pandemic levels. Single-family rentals and manufactured-housing REITs are experiencing similar pricing power, recently posting double-digit leasing spreads on renewals. Such favorable conditions are expected to continue.  

 

The worst-performing sectors during the quarter were the gaming and lodging REITs. Not surprisingly, the spike in cases from the Delta variant was felt most acutely in the hotel sector. Despite the recent slowdown in business travel, lodging demand is expected to make a robust recovery by mid 2022. For gaming REITs, the VICI/MGP merger required the issuance of $3.5 billion in new equity, heavily weighing on the sector’s performance during the quarter. 

Europe  After strong performance in July and August as a result of solid corporate earnings reports and the reopening of European economies after lockdown, the European public real estate market gave up those gains in a weak September.

 

The European REIT index saw a steep negative return of minus 10.2% (U.S. dollar gross total return) in September, making it the weakest of the three global regions for the month. For the third quarter as a whole, Europe finished in second place, with a total return of minus 2.2%, behind North America but ahead of Asia Pacific. The U.S. dollar climbed against all of the major European currencies (the pound, the euro and the Swedish krona) in the third quarter, depressing returns across the region. 

 

September’s share price falls were triggered by a combination of bond yield spikes on renewed inflation fears and concerns that supply chain interruptions could delay economic recovery in parts of the region. From a sector perspective, the industrial and self-storage sectors maintained their strong earnings and share price momentum. Retail continued to struggle in the quarter after experiencing a brief reopening boost. Office performance was more mixed in the quarter, with the UK doing better than other countries as employees began returning to offices there, as vaccination rates climbed and as the economy reopened. 

Asia Pacific  The region was in risk-off mode during the quarter, which stemmed from (1) low vaccination rates, with the exception of Singapore; (2) expansion of geographic lockdown and duration of lockdown in Japan and Australia; and  (3) regulatory tightening in China, which lowered the medium-term growth rate of companies in China and Hong Kong. 

Among subsectors, Hong Kong developers (minus 14.1%5 in U.S. dollar terms) were the main drags because sentiment was dampened by news of debt-laden Chinese developer Evergrande’s possible collapse and worries about the implementation of a common prosperity policy in Hong Kong. On the other hand, Japanese and Singaporean developers rose 2.1% and 0.4%, respectively. For REITs, Japan’s REITs fell the most (minus 5.0%), followed by Singapore’s (minus 2.5%) and Australia’s (minus 0.9%). It is of note that depreciation of the Australian dollar against the U.S. dollar more than wiped out gains in local Australian dollar terms for the quarter. 

For more details, read the full Market Review and Outlook, which is available for financial professionals. 

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Investing in real estate poses certain risks related to overall and specific economic conditions, as well as risks related to individual property, credit, and interest rate fluctuations. Real estate investment trusts (REITs) may not be suitable for all investors. There is no guarantee a REIT will pay distributions given the inherent risks associated with the market. A REIT may fail to qualify as a REIT as defined in the Tax Code, which could affect operations and negatively impact the ability to make distributions. There is no guarantee a REIT’s investment objectives will be achieved. 

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