The recent volatility in all financial markets is forcing investors to reset parameters for the short and possibly intermediate term. While we indicated in our last missive that, in general, if one has built a solid asset allocation there is probably very little to do at the moment, it may be a good exercise to scan for possible dislocations that may improve performance or yield on a longer time scale.
The recent interest cut from the Fed, a rare intra-meeting emergency reduction of 50 basis points, has pushed the yield on the all-important 10-year US Treasury benchmark down to around 1% (with intraday lows below that level as well). The Fed aims at providing liquidity to the system and therefore reducing financial frictions at a time of economic uncertainty driven by the spreading of the Corona virus. The result of this action will probably help the corporate bond market and increase the attractiveness of the real estate market.
In terms of REITs (listed commercial real estate), as of last Friday the sudden correction had made the sector much more appealing than just a couple of months before. Premia over Net Asset Values had been drastically reduced and, in many cases, had turned into discounts. The recent cut in interest rates adds to the positives, making REITs a possibly more interesting alternative to bonds for income investors. Of course, REITs do carry more volatility than bonds (even than corporate bonds) but that is not necessarily a big issue if the time horizon is not too short.
The following are some statistics provided by JP Morgan as of Friday’s close:
- The average premium to NAV in their REITs universe was a mere 0.8%
- The average yield in their REITs universe was 3.8%
- The office subsector traded at a 15% discount to NAV with yields at 3.4%
- The industrial subsector reduced its premium to NAV to 2.5% (with most names trading at a discount and one name still at a significant premium)
- The health care subsector showed yield in excess of 5%
- Diversified REITs showed yields in excess of 5%
Of course, the sector has enjoyed a good rebound since the Fed’s announcement (approximately 4% as of this writing) making these numbers a little less attractive. However, the collapse in rates does seem to strengthen the case for REITs. Ultimately, how deep the virus-induced contraction will turn out to be remains the wild card in any valuation made today; however, the REIT space does offer competitive yields and a business model probably more sheltered than others in the current environment.