Speaking to Investment Week, Todd Kellenberger, REIT client portfolio manager at Principal Asset Management, said these two issues must be "at the forefront of investor minds when considering REITs".
"Commercial real estate is currently in the eye of a central-bank induced storm, with stickier-than-anticipated inflation requiring continued hawkish bank rhetoric and further rate increases," Kellenberger explained. "This has pushed back expectations for central bank rate cuts, increasing upward pressure on bond yields and negative pressure on real estate values and REIT stock prices.
"The prospect of a banking crisis driven credit crunch has added to the pressure on the capital-intensive real estate sector."
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Head of property research at Quilter Cheviot Oli Creasey also noted the "massive impact" rising interest rates have had on property, particularly both prices and income yield.
"REIT shares have consequently suffered - the UK sector index has fallen -27% from its August peak," he said. "REITs started this recent downturn looking cheap, and so we estimate that on average the sector is still trading at 20-25% discount to net asset value, something we expect to correct over time, perhaps catalysed once interest rate rises stop, or we see signals of rates falling back again."
However, Kellenberger also argued the headwinds brought on by rising rates are due to end soon, and although a "significant economic slowdown" could put pressure on REIT absolute returns, it would offer central banks an opening to "skew dovish" and begin to cut rates.
Such an event would provide the catalyst to begin a new return cycle for the sector, he said, noting that REITs have typically performed well against equities in the 12 months following a real yield peak.
"Challenged capital market conditions from a weakening banking sector could remain an overhang and any signals of improvement would be another catalyst," he added.
Offices
Concerns were abound for the office real estate market, most notably marked by the departure of HSBC from its famous Canary Wharf tower.
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Laura Elkin, portfolio manager at AEW UK REIT, argued the office market was in a "state of flux" due to the "still stabilising" occupancy levels and high cost of strong sustainability credentials for buildings.
Kellenberger said these investor concerns were "warranted" but argued that office REITs comprise a small portion of the public real estate markets.
Elkin took a different approach, noting the potential for developing office spaces into other uses, citing the example of their sale of Oxford's Eastpoint Business Park.
"As a condition of this letting, AEWU's asset management team sought planning consent for change of use away from the asset's existing office use, setting a precedent for healthcare and life science use in the location and enabling the company to realise considerable profit on disposal," she explained.
Investment options
Richard Parfect, fund manager at Momentum Global Investment Management, argued REITs are their preferred option for investing in property, as the nature of permanent capital vehicles offers a "degree of liquidity certainty" which enables managers to make long term investment decisions.
"There is now a broad selection between generalist multi-sector offerings to more specialist trusts," he added. "It is possible to target a specific geography or rifle shoot into activities such as UK laboratories, GP surgeries, industrial warehouses or even private rented sector accommodation or ‘PRS'."
Of this broad selection, Quilter Cheviot's Creasey argued the abrdn UK Real Estate Share fund was a "good place to start", providing investors access to a range of vehicles, without any direct property exposure.
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Of the funds offering a hybrid approach, investing both in REITs and property, Creasey suggested the TIME: Investments Property Long Income & Growth fund as a UK focused example.
"While still small and young, its preference for alternative asset classes - it has notably avoided office and retail properties - has served it well," he said.
He also suggested the Columbia Threadneedle Property Growth & Income fund, which also has a hybrid approach but draws exposure from across Europe.
"The team also run the TR Property trust - the FTSE 250 listed investment trust that operates with a similar hybrid style, albeit with a higher weighting towards UK and European REITs than the above funds, and a preference for smaller REITs (liquidity is less of an issue for the closed-ended vehicle)," he added.
"The trust is today trading at a 7% discount to NAV, and that NAV is based on REIT shares which are themselves at a significant discount. It therefore looks inexpensive in our view, especially given the high-quality portfolio and management team."