Todd Kellenberger, REIT client portfolio manager at Principal Asset Management, was a guest on the latest episode of Nareit’s REIT Report podcast.
Kellenberger noted that listed REITs currently trade at significant valuation discounts to both equities and private real estate. He pointed out that the earnings price multiple of REITs versus equities today is over two standard deviations away from the long-term mean—"a level that's even cheaper than what we saw during the GFC, particularly for U.S. listed REITs.”
Meanwhile, the change in valuations for private real estate have been slower than for listed REITs, given the appraisal-based methodologies and limited price discovery in today's transaction markets, he added.
“The current implied cap rate that REITs trade at suggests a pretty attractive return premium potential over private real estate today. Looking at the future, that valuation gap between private and public real estate markets means the convergence trade really favors public REITs,” Kellenberger said.
Elsewhere in the interview, Kellenberger noted that:
- While capital market activity has slowed this year, REITs have continued to fund acquisitions or projects with debt or equity capital.
- Principal expects that tight lending conditions and less available capital for real estate could persist until bank balance sheet issues are resolved. Until then, expect some sluggish real estate transaction markets and pressure on values.
- Principal’s investment approach emphasizes resiliency for anticipated tougher macroeconomic conditions ahead. “We are expressing a preference for companies with resilient pricing power, lower economic sensitivity, and a favorable exposure to those structural growth drivers.”
- Banks and equity holders of real estate need to start accepting the pain that has already been priced into listed REITs. At current interest rate levels, real estate values must come down. “When that's done, we will likely see a greater willingness to lend and transaction markets pick up. This will help pave a way for capital to flow back into the real estate market.”