[TOP STORY] The impact of inflation on Reits

‘It’s a global phenomenon that the Reits of today are not the Reits of 2008. They have dealt with their debt issues’: Garreth Elston of Reitway Global.

SIMON BROWN: I’m chatting now with Garreth Elston from Reitway Global about the impact of inflation on Reits, real estate investment trust stocks. Garreth, I appreciate your early morning as always.

Inflation and Reits? Obviously inflation has arrived – the debate is how long will it stay and where do interest rates go? Let’s park that for a moment and [consider] intuitively whether inflation is necessarily bad for Reits, is it neutral, or is it potentially even positive for those real estate investment trusts?

GARRETH ELSTON: The general assumption is that inflation is bad, which is actually erroneous. Typically inflation is an opportunity for Reits to see improving rentals. It normally also is an indicator of an economy that’s growing and actually performing, and that comes through in more positive results.

I’ll just give you one example, a very recent study done by Cushman and Wakefield in the international markets, primarily on the US, looking at about 40 years of data.

What they found was that for every 1% of increase in inflation Reit total returns on average would go up by about 4.5%. Obviously certain sectors would go up even more than that.

For industrials, for example, it goes up by about 6.4% on average. So the numbers do back it up as well. But over the short term we often see people panic a little bit, unfortunately.

SIMON BROWN: … I take the point you mentioned, the economy is growing – and I get that. But I imagine increases for a lot of the leases and the like are going to be CPI-linked, which means you almost just lock them in – [there’s] not even a negotiation; you signed that lease three years ago?

GARRETH ELSTON: Yes. With a lot of the companies, with inflation being so low historically prior to now, they haven’t been able to exercise those in certain markets. So now they finally have the opportunity to have this come through, and come through quite strongly. Obviously you don’t want the economy to completely go in the other direction and inflation gets out of control, but [in] a controlled manner it actually is very positive for the sector.

SIMON BROWN: Yeah. Agreed on that. We don’t want rampant inflation, but a little bit isn’t necessarily the worst thing. Of course, within the Reits there are sectors; there are industrials on the one end and office on the other end.

We’ve chatted office before. Almost in a sense we are coming towards the end of the pandemic. Things are starting to improve. This almost gives them a bit of an extra sort of spurt in what could potentially be a good year and perhaps a good couple of years for the Reit sector – or am I perhaps a little overly optimistic?.

GARRETH ELSTON: No, I think we are having a return to normality, which is great. It’s been a couple of trying years, especially for sectors like retail, but it is looking a bit more positive and things are returning to something more akin to normal. I think we do expect to see a few more positive years. It’s certainly not going to be without volatility. That just never stops.

But in general, things are getting a little bit normal. The only laggard [where] we’re probably still waiting to see how things pan out will probably be office, but our view has always been pretty constant on this: that, as things return to normal, office will more than likely return to far more normality than people are assuming.

SIMON BROWN: A fair point to say is that in many cases – and we see this across listed stocks – they’re a little bit better off. They’ve reduced debt. They’ve got rid of some non-core, perhaps B-grade assets that they held. They are just generally looking in better positions and pricings are at or slightly below Nav rather than the premium we were paying five years ago.

GARRETH ELSTON: Yes. It’s a global phenomenon that the Reits of today are not the Reits of 2008. They have dealt with their debt issues, the debt maturities are set out a lot longer, the vast majority of debt is fixed. It is set. They know where things are moving over long periods of time. So it’s very different from the way things were and I think we have a lot of people who assume that you’re going to have the same type of problems in the sector. They’re focusing on the last crisis, which not where we currently are.

SIMON BROWN: Yes. We need to be actually looking forward. Garreth Elson from Reitway Global, I appreciate the insights this morning.

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How does that multiplier work?

REIT are highly leveraged so their interest cost would step up.

Also, REIT face (in SA) above inflation regulated price increases and have a limit to rental escalations. The old days of 7.5% rental increases (that eventually lead to a massive downward repricing after end of lease) are gone. Clever tenants sign up for JIBAR linked increases and JIBAR runs a lot below what real owner cost increases are.

Lastly, REIT seem to operate on “earnings” that are managed through revaluations. The vacancies will be higher and cap rate higher in high inflation? That leaves less opportunity to manipulate the earnings management chase. I would love to see what proportion of the last decade worth of earnings were real vs journal entries.

End of comments.

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