While publicly traded real estate investment trusts have been impacted by rising interest rates, the extent of the impact varies from market to market, said Corrado Russo, managing partner and head of global securities at Hazelview Investments, during a session at the Canadian Investment Review‘s 2022 Risk Management Conference.
“It’s not shocking to see those [markets] that have been more open in terms of the economy coming out of COVID and have experienced more inflation — and therefore are more at risk of further rising rates — have seen a bigger impact on … publicly traded real estate.”
Read: Value creation may be new cap rate compression in real estate investment
While a recession hasn’t been officially declared, it’s already been priced into U.S. REITs, he said, adding he believes inflation has peaked and will decrease in the second half of 2022, leading to a return of normal liquidity.
“If you do get a recession, rates start to come down again and that supports real estate pricing and it supports public real estate. This tells me if you think we’re in a recession or going to go into a recession, you should buy REITs, but if you don’t think we are going into recession then you should buy U.S. equities. And if you have no idea, then you should probably buy REITs because they give you a typical average return of about 40 per cent cumulative in either scenario.”
Russo noted REITS closely follow private real estate values and are subject to short-term variables such as fund flows. However, despite price drops, the intrinsic value of the buildings hasn’t changed.
Read: HOOPP exchanges property portfolio for stake in new REIT
“People get scared, there’s more sellers than there are buyers, it takes prices down. . . . What it means is that in the public markets, there are people that are looking for the exit to either go to cash or to find opportunities elsewhere. And that’s typically when you’ve seen a significant outsized return, if you have the courage to buy into those environments. Typically, what we’ve seen is if you’re buying at these levels, you’re typically set up for multiple years — two to five years of double-digit returns to get back to that trend line.”
And with public markets already pricing in a recession, there’s an opportunity for institutional investors, said Russo, citing an exercise among publicly traded companies underwritten by Hazelview that projected annualized returns of between 13 per cent and 15 per cent over the next three years.
“Let’s take our cap rates higher, let’s change our growth rates and bring them down lower, let’s increase our overall cost to capital for our underlying companies and then redo the exercise based on where the companies are trading today versus where they were at the beginning of the year. . . . With all that priced in, we are seeing 13 to 15 per cent expected returns. If you think we fall short of those negative assumptions and cap rates go back to where they were, then that [return] becomes more like a 15 to 25 per cent potential.”