Economy
Meredith Whitney, who previously forecasted the financial crisis in the mid-2000s, sees downside for the housing market, driven by changes in behavior among younger men. She sees the beginning of a multiyear decline in housing prices as the lower levels of household formation among men negatively impact demand.
On the supply side, she sees more homes for sale due to the aging demographics of homeowners. Whitney’s perspective deviates from the consensus, which sees home prices as remaining elevated due to a lack of supply, coupled with a bulge in demand as Millennials enter their peak consumption years over the next decade. This year, most Wall Street banks are forecasting a mid-single digits increase in home prices.
Another factor impacting housing supply is that the vast majority of mortgages were made at much lower rates. While many asset prices have declined due to the impact of high rates, home prices are an exception. Whitney contends that “normally you would think as rates go up, home prices would go down, and that hasn’t happened over the last two years. I think home prices will normalize because as more inventory and supply come on the market, you’ll see a true clearing price that is lower than it is today. So, I would say 20% lower than it is today.”
Finsum: The consensus view is that home prices will continue rising due to low supply and demographic-driven demand. Meredith Whitney, well-regarded for predicting the financial crisis, is bearish on the asset class.
REITs have had an uneven start to the year due to the outlook for monetary policy becoming less dovish. Many investors are interested in taking advantage of this weakness, given the sector’s solid fundamentals and attractive yields. Yet, they may want to minimize exposure to volatility, which is likely to persist given an uncertain outlook for monetary policy. So, here are two lower volatility REITs for more conservative investors.
W.P. Carey (WPC) owns commercial and industrial properties across North America and has a 6.2% dividend yield. WPC is extremely diversified, as no single industry accounts for more than 10% of its tenants, and its biggest single tenant accounts for less than 3% of total revenue.
In addition to its diversification, WPC also has less risk than competitors due to being a net-lease REIT. This means tenants cover taxes, insurance, and maintenance. The company also negotiates rental rate increases that are built into contracts, providing another layer of security.
Digital Realty Trust (DLR) provides exposure to data centers, pays a 3.4% yield, and has hiked its dividend every year since 2005. This segment saw massive growth over the last decade due to the rise of cloud computing and should enjoy another healthy tailwind over the next decade due to artificial intelligence.
DLR’s data centers enable the distribution of technology to users for consumer and commercial applications. The company has more than 300 data centers in over 25 countries and counts companies like Meta, JPMorgan Chase, and Verizon among its customers.
Finsum: REITs have underperformed to start the year. Yet, the sector still holds appeal due to attractive yields and solid fundamentals. DLR and WPC are two REITs with lower volatility that may appeal to more conservative REIT investors.
2024 has been underwhelming so far for REITs, as evidenced by the iShares US Real Estate ETF’s YTD 4.5% decline, while the S&P 500 is up 9% YTD. Two major reasons for this underperformance are continued struggles for the office segment and less clarity about the outlook for monetary policy, following a series of stronger than expected labor market and inflation data.
However, the intermediate-term outlook for the sector remains favorable due to attractive yields and earnings growth despite a challenging, near-term environment. Further, most segments are in good shape. According to Steve Brown, the senior portfolio manager at American Century Investments, “The REIT industry is very diversified among different sectors like data centers, towers, and industrial, and office is only about 4 or 5 percent of the index. So while office has issues, many other property sectors have pricing power and can raise rents greater than inflation.”
He also favors public REITs over private REITs, as public REITs are cheaper while offering more liquidity. He notes that many private REITs are still trading at or just above net asset value (NAV), while public REITs are trading at an average 20% discount to NAV. Overall, he sees a much more benign environment in 2024, especially once the Fed starts cutting rates.
Finsum: REITs have had a rocky start to the year. However, the fundamentals for the sector continue to improve, while many of its challenges are already reflected in depressed valuations.
More...
Last year, real estate transactions declined by 50%, while cap rates increased by 80 basis points. Many sellers were unwilling to let go of properties at lower prices, while buyers contended with a higher cost of capital and macroeconomic uncertainties. Another headwind was that many banks pulled back from lending due to balance sheet concerns, following the regional banking crisis.
This year, KKR is forecasting that real estate transactions will pick up, and there will be many opportunities for investors. Additionally, private real estate investors are well-positioned to step into the vacuum and provide financing for high-quality real estate at attractive terms.
KKR notes some catalysts that should result in transaction volume increasing. The firm believes that real estate values are near a bottom especially as the Fed is at the end of its hiking cycle and looking to cut in the coming months.
It also notes that REITs are a leading indicator for private real estate and have already embarked on a robust rally. Further, many real estate private equity funds have ample cash and have been on the sidelines for the last year and a half. Finally, many owners and operators will be forced to sell given that many loans are due to be refinanced in the coming years. In total, $1.6 trillion of real estate debt will be maturing in the next 3 years.
Finsum: Over the last 18 months, activity in real estate has plummeted. KKR believes that we are close to a bottom. It sees attractive opportunities for private real estate investors especially given that many loans will need to be refinanced in the coming years in addition to an improvement in macroeconomic conditions.
Many asset managers are increasingly confident that private real estate is at or very close to the bottom of its cycle and presenting an opportunity for outsized returns. It’s a major shift from last year when many funds had to put limits on redemptions. This year, institutional investors are increasing allocations in anticipation of an improving macro environment.
Additionally, many believe that concerns about commercial real estate are exaggerated. Other than the office sector, most segments have strong fundamentals. Recently, deal volume has improved as sellers have come down on price. Overall, it’s estimated that prices are down on average by 18.5% from the peak.
Over the last decade, private real estate in the US generated annual returns of 6.4%. According to James Corl, the head of private real estate at Cohen & Steers, returns will average between 10% and 12% in 2024 and 2025. He added that returns in private real estate are highest a year after the Fed stops tightening.
Many investors are anticipating attractive deals in the coming months as there could be several forced sellers with many borrowers needing to refinance at higher rates. Over the next 2 years, $1.2 trillion of commercial real estate loans will mature. At the end of the year, it was estimated that about $85.5 billion of this debt was distressed.
Finsum: Asset managers are increasingly bullish on private real estate. History shows that the asset class generates outsized returns in the periods that follow the end of a Fed tightening cycle.
An unusual recurrence in the markets is the ‘January effect’. This is the phenomenon of downgraded debt consistently outperforming in the first month of the year. This has taken place in 18 out of the past 21 years. 2024 is no different as the ICE US Fallen Angel High Yield 10% Constrained Index outperformed the ICE BofA US High Yield Index by 56 basis points. This year, the fallen angels index is composed primarily of real estate, retail, and telecom.
JPMorgan sees some risks of further downgrades in the coming months. Currently, the high-yield market is collectively worth $1.3 trillion. Of this, $1.05 trillion is rated BBB- by at least one rating agency, and $111 billion is on negative watch by at least one agency. The bank sees risk of sector-specific weakness in real estate leading to more downgrades. It also notes a lesser risk of the economy slowing leading to more downgrades.
Over the last 3 months, 5 REITs have joined the fallen angels index and now comprise 12% of the index. Some issues are leverage, lower renewal rates, lack of recovery in office vacancies, and higher insurance costs. The sector is expected to remain under pressure, especially in commercial real estate, as $2.2 trillion in loans is expected to mature between now and 2027.
Finsum: REITs are the largest component of the fallen angels’ index due to secular issues in commercial property and cyclical pressures created by high rates.