Real estate: 'Safety' becomes more expensive

Attractive investment opportunities still exist but are much harder to come by, as wary investors flock to 'safer' REIT names.

Edward Mui 8 July, 2016 | 5:00PM
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Morningstar's real estate coverage looks reasonably priced; the sector trades at a 3% aggregate discount to our fair value estimates. We believe investors should continue to be selective in the sector, as we expect increasingly uncertain economic conditions to continue to affect capital access and activity, asset pricing and operating fundamentals throughout the year.

The market is still attempting to reconcile the implications of interest-rate expectations for real estate valuations. Higher interest rates could put pressure on growth rates, cap rates and return expectations. Also, to the extent that low interest rates have diverted investor funds to REITs searching for higher yield, the same funds could flow out of REITs if interest rates rise, further pressuring commercial real estate and REIT valuations.

However, we still expect U.S. interest rates to remain historically low for an extended period. Investors see the U.S. as a relative safe haven for investment capital, and 10-year U.S. Treasury yields continue to compress amid global yields coming down overall. Additionally, the U.S. economy seems more and more vulnerable to a slowdown, highlighted by weakness in recent job reports. Altogether, this has prompted policymakers to revisit where they want rates to go and how quickly they want them to get there.

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Edward Mui

Edward Mui  Edward Mui is an equity analyst for Morningstar.

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