Date
15 November 2018
A Hong Kong property covered by Link real estate investment trust. As long as the economic backdrop allows for rental increases, REIT income will remain more protected than bond alternatives. Photo: HKEJ
A Hong Kong property covered by Link real estate investment trust. As long as the economic backdrop allows for rental increases, REIT income will remain more protected than bond alternatives. Photo: HKEJ

Why REITs outperform bonds during an interest rate upcycle

Since 2015, Admiral Investment has reported on the long-term performance of Asia-Pacific and Asian REITs against other asset classes that are commonly considered by institutional and individual investors.

The first paper, published in early 2015 and using data from 2001 to the end of 2014, showed that Asia-Pacific REITs have historically maintained a 4 to 6 percent dividend yield and a low double-digit total return, while showing favorable Sharpe ratio and diversification benefits against equities, bonds, and REITs from other regions.

Subsequently, we updated the analysis twice, first in mid-2016 and then in March 2018, to reflect data from 2001 to the end of 2017. REIT performance over the last three years (2014-2017) has been weaker than the historical average, with Asia-Pacific REITs returning 7.95 percent and Asia-only REITs returning 5.13 percent.

However, the returns of 2017 have reached a more historically-average level of 11.69 percent for AP REITs and 9.55 percent for Asia-only REITs. This lowers the long-term average return from over 12 percent in the last report to 11.38 percent for AP REITs and 10.77 percent for Asia-only REITs. The lower returns, however, are still within the upper end of what investors expect for a core-like real estate program.

While the interest rate environment has led to weak performance for bonds in the one-, three-, and five-year time scale, REITs in most regions have performance at or above their long-term trends. The fact that REITs have income streams that grow during economic expansion is a strong reason that it outperforms bonds during an interest rate upcycle.

The central reason why REITs typically outperform during interest rate increases is that the dividend income increases as REITs increase their rents. In fact, in 2017 dividend income has increased by more than 10 percent, which brought the dividend yield up from 4.40 percent in 2016 to 4.68 percent in 2017. The strong dividend growth allows for both a dividend yield expansion and a positive price return. Going forward, as long as the economic backdrop allows for rental increases, REIT income will remain more protected than bond alternatives.

Adding the newest data continued to support the observations that AP and Asian REITs have higher Sharpe ratios than equity and REITs in other regions. The newest results support the observations that AP and Asian REITs diversify against equity and other investment classes. Investors adding REITs to their portfolio can reduce return volatility and increase medium- to long-term return. This is perhaps the long-term reasons underlying the continued growth of the sector.

REITs have also grown as an asset class over the last two decades. Asia-Pacific REITs started in 2001, when Japan listed the first Asian REIT (Nippon Building Fund). Before that, REITs only existed as a small sector in Australia and New Zealand, with a total of 24 entities and a total market cap of US$7.8 billion at the end of 1999.

From this small foothold, REITs have recorded growth almost every year since then. At the end of 2017, 245 Asia-Pacific REITs, with a total market cap of US$330 billion, were listed in Australia, Japan, Singapore, Hong Kong, and other smaller markets including Taiwan, Malaysia, Thailand and India. Several Singapore- or Hong Kong-listed REITs were also dedicated to assets located in China and Indonesia.

The simple average market capitalization of Asia-Pacific REITs reached US$1.35 billion, representing a more than four-fold growth from US$320 million in 1999. We believe that this suggests that Asia-Pacific REITs have matured into a standalone sector.

– Contact us at [email protected]

CG

Chief Investment Officer, Admiral Investment Ltd.

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