Real Estate Forum - October 2013

HOW LONG WILL THE REIT RUN LAST?

So, how long will the REIT run last? To ask this is to ask where we are in the real estate cycle. Crowe says we’re still behind the halfway mark and points to what he sees as a noteworthy fact to consider when assessing the big picture: the economy has been sluggish and recession-like for five years now, and we’re just starting to claw our way out of it.

“Due to the length of the downturn, I see a commensurately
long-tailed upturn, which is driven by a couple things,” Crowe says.
“The first is that interest rates are still going to stay low. The econ-
omy can’t tolerate high rates right now, and second, the supply,
which tends to derail real estate cycles is low.”
Crowe is betting on a multi-year run in real estate values and
with that, REIT share prices. He thinks the market has another 10
years ahead before this cycle finishes. His thoughts seem reason-
able, considering that real estate cycles tend to be 15 years in
length and the last one ended in 2007. The US economy spent five
years in doldrums, which would signal a 10-year real estate upturn
cycle ahead. That reflects directly into REIT share prices.

“The rental growth potential for real estate assets is going to
surprise people,” Crowe says. “We’re not used to this low level of
supply. While interest rates have moved up from astonishingly low
levels, they are still at historical lows. That’s a very good backdrop
for commercial real estate. I just finished about 20 company meet-
ings at a real estate conference, and nobody is seeing any change in
investor appetite for real estate, nor pricing. So what that means,
again, is that this correction represents one of those very unique,
phenomenal buying opportunities when the market overreacts.”
Every time Gates thinks it’s hard to imagine earnings multiples
increasing based on fundamentals, some structural shift happens
to drive those multiples ever higher. The most recent shift was a
move to a long-term managed economy, which ultimately resulted
in a structural shift of interest rates.

“When interest rates came down precipitously on a secular rather than a cyclical basis, it paved the way for increased valuations of REITs and CRE in general,” Gates says. “In other words, because yields are so low in all other asset classes, investors were effectively driven into real estate, with REITs often being the proxy as they searched for higher yields or yields that were perhaps a bit more inflation-protected than traditional fixed-income instruments. It’s hard to imagine REIT relative valuations for the entire asset class pushing much beyond where they’ve reached. I hope I’m wrong.” “The long-term picture for REITs is solid,” Farquharson says. “Real estate is a cornerstone of any investment portfolio, and REITs are the most efficient way to gain exposure to real estate. In terms of what lies ahead, I think we will see which management teams are able to navigate through a changing interest rate environment. It will not be easy, but many management teams have experienced previous cycles and will be up to the task. I also believe we will see the REIT product continue to evolve and be expanded to non-tra-ditional real estate assets and foreign jurisdictions.” ◆