By Harvest ETFs
Real estate assets perform well during inflation. That thesis has held through past periods of significant inflation, notably in the 70s, as well as the late ‘80s and early ‘90s. A 2021 report from Amundi research discussing inflationary risks as economies reopened highlighted real estate as a key inflation hedge for long-term investors. That is because real estate investments typically have rents indexed to inflation and can generate strong cashflows through these periods.
With that thesis in mind, many investors may be looking for opportunities in the REIT space. REITs are easy to invest in and offer cashflow generated on the strength of a real estate asset. Not all REITs are created equal, though. According to Paul MacDonald, Portfolio Manager and Chief Investment Officer at Harvest ETFs, Canadian investors should look at global options to find the scale and diversity of opportunity they need.
“In a global portfolio, investors have access to far more kinds of real estate than the typical mix of strip-mall commercial and multifamily apartments you get with Canadian REITs,” MacDonald said. “These are income yielding properties that have historical resistance to inflation, with a more diverse array of asset types that can supplement some of the more traditional REIT types found in Canada.”
How global REITs can offset inflation
REITs tend to perform well during inflationary periods for a few core reasons. The first is higher demand from economic growth. Inflation typically occurs in periods of positive growth, much like what we’re experiencing now, which comes with higher demand for property. In today’s environment you have a global economy still in recovery mode, meaning demand for properties to facilitate that recovery is strong.
Typically, as well, commercial leases and contracts will have inflation-linked annual increases in rents written in. Certain asset classes can respond even more rapidly. Storage units, for example, typically set their rates monthly, weekly, or even daily meaning they can respond to inflation very quickly.
With inflation comes the risk of rising interest rates, which can have a negative impact on particular asset classes. That is why a diversified global portfolio can be so useful for a REIT investor. A varied mix of asset classes and geographies with different market conditions can offset some of the risk exposure one real estate style or market might be subject to.
MacDonald breaks down asset classes into two key areas that roughly follow the broad market categories of ‘value’ and ‘growth.’ ‘Value’ REITs hold consistent and largely defensive asset classes like multifamily apartment housing or retail strip malls. These are the sorts of REITs that are easy to find in Canada. ‘Growth’ REITs are not necessarily growth assets like tech stocks in and of themselves, but they are exposed to key growth areas in our economy. They include last-mile warehouses for ecommerce, data centers, cell phone towers, and the aforementioned storage lockers. These asset classes are rare in Canadian REITs but can be found across key global markets.
Why some ‘growth’ REITs are discounted
Harvest Global REIT Leaders Income ETF (HGR:TSX) was built to offer Canadian investors exposure to the unique real estate opportunities that domestic REITs simply don’t hold. It offers what MacDonald refers to as a “barbell” approach, weighting more ‘value’ REITs (like those that you would get mostly in Canada) against REITs that own properties vital to rapidly growing sectors.
“You have access to what I would call more ‘growth-oriented’ REITs that hold properties like last-mile warehouses, data centers, and storage units,” MacDonald explained. “These are all property types with real fundamental strength but they’ve sold off somewhat recently as investors have rotated from growth to value. That means I can buy the cashflow and growth potential these REITs provide for far less than I could even six weeks ago.”
Comparing global REITs, which hold more growth assets, and Canadian REITs, MacDonald highlighted that the price of global REITs have come down significantly in 2022 while their cashflows have actually gone up. Canadian REITs, on the other hand, have seen their value hold steady or rise, while cashflows remain close to the lows they hit in spring of 2020.
From MacDonald’s perspective, by allocating some assets to the global REIT market, it means an investor looking at REITs for inflation-resistant cashflow, can get the better Global cashflow profile at similar prices to the more mature and stagnant cashflows of Canadian REITs.
“By going global today, you are able to find better quality, growing opportunities for more palatable prices than just a short while ago,” MacDonald said. “It’s the same building, the same tenants, and the same occupancy rate that’s going for cheaper because of this macro market rotation.
“Looking through this valley, investors should know that real estate assets do well in times of inflation and modest economic growth, like what we see today. Investors can now buy real assets for cheaper than they could just a short time ago and still get solid cashflow thanks to the structural drivers behind this demand for real estate. Given that this opportunity exists offshore, I think now is a good time for people looking at real estate to explore a global holding that can complement their Canadian assets.”
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