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Quarter-End Insights

Real Estate: REITs That Can Weather a Rising Rate Environment

Rising interest rates could be a major valuation headwind for REITs, so investors should focus on moaty landlords with good growth prospects and attractive relative valuations.

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  • U.S. real estate investment trusts appear overvalued as a group, with pockets of opportunity in the health-care, retail, and cell tower property sectors. We maintain the view that Australian property stocks are similarly expensive, but with higher yields than similar REITs elsewhere.
  • Capital is increasingly flowing across borders for property investments, and property values are high.
  • With acquisition prices high, more REITs are expanding their development pipelines, with initial yields projected to be 200 basis points or more above acquisition cap rates.
  • We generally expect REIT prices to move inversely with changes in long-term government bond yields, so we expect REITs to underperform in a rising interest-rate environment.

U.S. REITs appear overvalued as a group, with pockets of opportunity in the health-care, retail, and cell tower property sectors. Most Australian property stocks appear fully valued, but we see some value in the industrial and senior living sectors. Singaporean REITs are fairly valued, but we prefer office over retail. Limited new supply of office space in the central business district in 2015 is supportive of rental growth. Although office construction will add meaningful new supply in 2016, this should be absorbed by increased tenant demand as Singapore remains a premier location for multinationals' regional headquarters. In general, we think global commercial real estate investors should be cautious in the current environment and focus on the highest-quality firms and property portfolios.

Todd Lukasik does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.