When it comes to splitting the investment trust sector, the choice is either to look at investment type (equities versus alternatives) or fund objective (growth versus income) – we go with the latter. Here we will take a look at the real estate sector through the Reits, which have their own drivers and straddle both growth and income.
Real estate investment trusts (Reits) make up a sizable part of the London investment market, frequently present valuation gaps and can offer attractive income. Recent times have been turbulent for Reits, though, thanks to a trifecta of falling demand, pressure on rents and, most significantly, the interest rate environment, which has impacted the ‘cap’ or ‘capitalisation’ yields used to establish asset values. Lower rental growth means higher yields, but for real estate the market also considers the ‘yield gap’ between the cap yields used for sector valuations and risk-free returns (RFRs – typically gilts) – typically property yields more than gilts so cap yields have had to increase.
However, despite economic headwinds, rents in general are not falling, only rising more slowly. Demand has skewed much more towards prime assets, with many occupiers looking for smaller (due to home working) but better premises. Some poorer quality space is proving unlettable and will have to be repurposed. A more material risk for this sector than tenant-related issues is concern about contagion from banking failures or banks otherwise becoming less keen to refinance Reits. This concern has caused many institutions to lose interest in the sector, triggering something of a sell-off, leaving many stocks on substantial discounts to their net asset value (NAV).