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REITs may be the solution to inflation concerns says Resolution
There is a common perception in capital markets that real estate prices are most heavily influenced by interest rate movements. Proponents suggest that an increasing cost of capital and loans will ultimately result in different types of property losing its value. Not so, says Resolution Capital’s CIO, Andrew Parsons. In fact, he suggests that investors should question this conventional wisdom.
Going further, Parsons suggests that real estate investment trusts (REITs) may actually offer a real inflation hedge. Commenting at a recent briefing for investors, he says “there’s plenty of evidence to demonstrate that REITs are not highly correlated to rising interest rates and bond yields, it’s a simple catchphrase that the market focuses on without actually looking at the history of returns.”
As is typically the case, relying on long-held beliefs and biases is fraught with risk, hence prospective investors “have to look deeper into what’s actually driving the economy and real estate fundamentals to understand the true effects of rising interest rates.” One area of particular interest is the clear signs that the cost of construction is rising, which Parsons says is likely to become a tailwind for REITs.
“What we’re seeing is a very significant increase in building costs. Important ingredients in building properties have been going up at a very dramatic rate in the last 12-18 months. That’s been a consequence of a number of factors, including the likes of the COVID disruptions ….. and the extraordinary government infrastructure plans.” As a result, he says that developers are facing the prospect of higher costs, which will force rents higher in order to justify investment in new buildings.
This relates directly to Resolution’s positive view on the sector as an inflation hedge, saying the firm believes it is demonstrated by looking at the economic rent equation. “If you’re an existing building owner, what this effectively does is cushions you against new competition, because you’ve got a cost advantage and therefore it should in fact moderate the supply picture and underpin existing property values.”
Pointing to an example, Resolution highlights Prologis, a major US logistics REIT, which reported “that they are seeing record price increases in the construction of their logistics facilities. Fortunately for Prologis, they’re also enjoying extraordinary tenant demand, which is meaning that rent increases are matching these construction cost increases.
“What we think is most important is not to get focused on the catchphrases, but to actually look at the real returns that the sector can produce, and the drivers that are so important in determining that. For us, it’s about pricing power and capital management,” Parsons said.
