Indian equity market valuations have shot up significantly in the last 4-6 months. While the overall growth drivers of the Indian economy are intact, the consensus view across the board is that valuations in India are currently pricey and a healthy correction is foreseen across categories, with more downside seen in some midcap and smallcap counters. At this point, it would be prudent to harvest some gains and put capital in themes where valuations are sustainable and suitable risk-reward metrics exist.
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There is tremendous value in Global REITs at this point in time. Globally, REITs are a well-developed $1.9 trillion market comprising 893 listed stocks across 40 countries, exposure to which can help in significant diversification benefits. Unlike India where the oldest REIT has a vintage of 4 years, REITs in the US have been in existence since the 1960’s and have seen multiple cycles of growth, interest rate movements, inflation etc. In fact, over a 20- year time horizon, US REITs is the best performing asset class globally having generated annualized returns ($ terms) of ~11% p.a. Clubbed with the incremental return generation possibility due to INR depreciation (historical average of ~3-4% p.a), incremental yield generation is possible. The current high interest rate and high inflation environment has caused dislocation in valuations, giving a short window of opportunity. There is a possibility of making outsized returns over the next 3-4 year holding period, as market valuations of certain in-favour high-quality REITs converge to the underlying asset values (represented by NAV of the REIT).
How do Global REITs operate? How can exposure to this asset class help Investors to benefit from various themes prevailing within Real Estate?
Unlike India where public market real estate opportunities are mostly restricted to investing in Commercial Real estate REITs (barring a recently listed Retail REIT), the market for REIT’s globally is much more evolved and offers multiple sectoral themes within Real estate which can be played for generating alpha. There are public REIT’s available globally which focus on owning great quality assets across diverse sub-themes. REITs offer investors the benefits of real estate investment along with the ease and advantages of investing in publicly traded stock. REITs have historically provided investors dividend-based income, competitive market performance, transparency, liquidity, inflation protection and portfolio diversification.
REIT investments have shown a specialization trend by moving away from real estate holding companies having exposure to all asset classes to focused sectoral plays, with new REITs focusing on owning more in-favour asset classes like Warehousing assets, Infrastructure, Multi-family, datacentre, Healthcare etc. Investors should target to tactically harness the current dislocation in values of certain high-quality REITs.
What is the impact of the current high inflation and high interest rate environment on REIT Stocks?
Global REIT stocks are currently down c. 30% due to the current high inflation and high interest rate environment. Post the global financial crisis of 2008/09, REITs nearly tripled in less than 2 years. This outsized return cycle was repeated again in recent past when REITs nearly doubled in less than 2 years post the crash of 2020.
The general expectation is that we have already seen the peak of the rate cycle and the near-term peak on the inflation cycle. The US Fed also seems to have taken cognizance of the fact that the high interest rates prevailing are already restrictive. As inflation cools and interest rates revert to normal, there is a possibility of outsized returns in Global REITs as seen during similar periods in 2009 and 2020.
Apart from the currently attractive valuation, are there any other metrics to be considered while evaluating Global REITs stocks?
As I mentioned earlier, valuation of some Global REIT’s look very attractive and could generate significant alpha in the near term. Apart from dividend generation, some strong fundamental factors are at play which make the return generation prospect enticing.
Fund flow from Operations (FFO) is a key metric which shows the cash generation capacity of the REITS from its regular ongoing business activities. FFO is at an all-time high implying strong operating performance of underlying REIT stocks.
Due to the higher inflation environment, construction costs have increased sharply due to which the development pipeline has started to come down. This will drive higher occupancy and rental growth for existing core assets.
One more observable trend is the low levels of leverage amongst Global REITs. Both interest cost (as a %age of Operating income) and total debt levels (relative to the value of assets owned) are at low and sustainable levels.
Lastly, amongst the sectoral themes within Global REIT, the effect of the COVID pandemic is completely behind us as occupancy levels are back to ~95% (barring Office properties).
What are the avenues through which Indian Investors can participate in Global markets investing?
Indians looking to participate in Global investing should take cognizance of the prevailing tax structure, double tax implication and withholding taxes etc. First time investors in the global market may consider products like REIT stocks instead of direct venturing into equity investment in non-REIT stocks where significant volatilities can exist. REITs are total-return products (REITs are typically required by law to distribute at least 90% of their taxable income to investors).
However, considering the risks involved, it would be prudent for investors to exercise caution, do thorough due diligence and seek out the right investment guidance prior to investing. It is better to consider a direct model (with professional advice) than to go through the mutual fund route where such investments are facilitated through a Fund-of-Funds (FoF) approach. In FoFs, the Investment is first made in a Feeder Fund which will be pooled into another Global Fund. This structure is not cost efficient due to higher expense ratios (at both Indian Feeder Fund level and Global Fund level) and the penalisation through the Exit Load at time of divestment.
What potential returns can Indian investors anticipate when investing in global real estate securities?
Historically, US REIT is the best performing asset class globally having continuously generated annualized returns ($ terms) of ~11% p.a. (over a 20 years period). For Indian investors, investing globally gives a natural hedge due to INR depreciation (historical average of ~3-4% p.a) resulting in incremental yields.
The current high interest rate and high inflation environment has caused dislocation in REIT valuations (Stocks are down ~30% since peak), giving a tactical window to buy high-quality Global REIT stocks with strong fundamental drivers. As inflation cools and interest rates revert to normal, market valuations of certain in-favour high-quality REITs will quickly converge to the NAV’s resulting in significant alpha generation. While investing in the right REITs can generate IRRs of 20-25% for Indian investors, it is essential to pick the right themes/in-favour REITs for which credible professional advice should be sought.
Note: The author of this article is Ganesh Arunachalam, Head of Investments - North and West, PropShare Capital. The views and opinions expressed ar that of the author and do not reflect the opinions, views or beliefs of the website or its affiliates.
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This is an advertorial published as part of a marketing initiative. This has no editorial input, or editorial involvement. No CNBC-TV18 journalist was involved in writing, researching or editing this article. Views and opinions expressed, and ideas discussed are solely by Ganesh Arunachalam, Head of Investments - North and West, PropShare Capital and do not reflect the opinions, views or beliefs of the website or its affiliates.
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