Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 439

REIT sectors are different, faced with fundamentals and inflation

Commercial real estate is an asset class in which the range of outcomes varies by subcategory, and outcomes can tighten or widen depending on the inflation outlook. Fundamental research and ongoing engagement with management is a critical input in the investment decision-making process.

The hybrid features of REITs

To place them in their proper context, Real Estate Investment Trusts (REITs) are a hybrid of asset class that resides somewhere between equities and bonds. They’re viewed by investors as equities due to their potential for real capital growth, but also as bonds because of their income streams and focus on consistent capital return through dividend income.

Inflation matters in this asset class, though REIT performance during inflationary periods has been mixed.

The illustration below compares the performance of REITs in the US market (with more data points, liquidity and history than A-REITs) with that of equities during periods when core inflation is rising. While the type and level of inflation matters to the performance of REIT securities broadly, we think the fundamentals — the heterogeneity of the subcategories within the sector and the quality of the management teams and the assets they manage — are more important.

Inflation and different types of REITs

The simplest way to think about REITs is that they are landlords. Because they’re owners and operators of properties for rent, building-specific details such as location, regional supply and demand dynamics and the tenant mix matter. Things like lease structures, including duration of contracts, inflation indexation and replacement costs are also important.

As a general rule, REITs with shorter leases offer greater inflation protection than those with longer ones. Hotel and accommodation REITS, for example, have the shortest leases because hotel room rates fluctuate daily. While they can adjust prices to absorb higher costs, pricing power is a function of supply and demand. Currently, lodging fundamentals are mixed, with leisure demand on the rise but business travel impaired.

While lodging may not be mission critical, having a place to live is, and housing and apartment REITs have become a large part of the public REIT equity universe in the US. It is expected to grow in Australia.

As with lodging, labour and materials inflation are risk factors. At the same time, if replacement costs for comparable assets are rising, which often occurs during inflationary bursts, the intrinsic value of housing or apartment REIT portfolios is likely to appreciate too. Furthermore, if rents rise because of increased tenant demand amid tight housing supply, given relatively short lease durations (typically one year), apartment REITS should be able to pass that asset inflation on via higher prices, as they’ve been doing over the past 12 months.

Short lease lengths are a feature of self-storage REITs too. This industry has been a beneficiary of the pandemic as the work-from-home dynamic has caused many to declutter. The combination of increased demand and short leases equals price hikes and the potential to better absorb higher costs.

Conversely, long-lease subcategories such as grocery, freestanding retail and office landlords are more at risk. While grocery and retail have benefited from a stimulated consumer, office property fundamentals remain challenged. Vacancies are rising, with more tenants cutting back their space requirements as companies allow their employees to work from home. However, there are nuances, and office fundamentals vary by region and country.

While REITs have underperformed equities since the outbreak of the pandemic, strengthening fundamentals have pushed capitalisation rates down and valuations up, making REITs the market darlings of 2021.

However, we believe their continued recovery will be mixed and uneven. Tenant demands were changing before the pandemic and have only accelerated since. Occupancy costs matter more than ever, and efficient tenants will seek out space with the best value proposition. Against that backdrop, we favour landlords in mission-critical industries such as hospitals, medical offices, labs, residential, storage, data centres, industrial and fulfillment centres, among others.

'Just in case' replaces 'just in time'

What we’re hearing from companies is that 'just in time' supply-chain management is being replaced by a 'just in case' approach as many trade efficiency and margin for dependability and market share. The shift is inflationary. After years of labour cost suppression leaving workers feeling left behind, the demand for labour is now outstripping supply. Labour is taking more control from capital, workers are demanding higher compensation and getting it. That, too, is inflationary.

We believe there will be a tug-of-war between secular disinflationary forces such as technology and excessive debt that plagued the last business cycle and the aforementioned sources of the current cyclical upward price pressures. Regardless of where investor’ views fall on this continuum, everyone is thinking about inflation, and particularly how much of it there will be. Too much would have different implications than too little, but the implications of either eventuality would be negative for markets and society.

Like any other asset class, REITs are impacted by inflation, but the impacts vary depending upon the type of inflation and the REIT subcategory. To us, fundamentals and security selection, regardless of the economic and inflationary environment, matter most.


Robert Almeida is a Portfolio Manager and Global Investment Strategist, and Matthew Doherty is a Research Analyst at MFS Investment Management. These views are for informational purposes only and should not be relied upon as a recommendation to purchase any security or as a solicitation or investment advice. This article is issued in Australia by MFS International Australia Pty Ltd (ABN 68 607 579 537, AFSL 485343), a sponsor of Firstlinks.

For more articles and papers from MFS, please click here.

Unless otherwise indicated, logos and product and service names are trademarks of MFS® and its affiliates and may be registered in certain countries.



Global survey shows Australians least confident about retiring

'OK Boomer' responses keep on coming

Responses to the 'OK Boomer' poll


Most viewed in recent weeks

Lessons when a fund manager of the year is down 25%

Every successful fund manager suffers periods of underperformance, and investors who jump from fund to fund chasing results are likely to do badly. Selecting a manager is a long-term decision but what else?

2022 election survey results: disillusion and disappointment

In almost 1,000 responses, our readers differ in voting intentions versus polling of the general population, but they have little doubt who will win and there is widespread disappointment with our politics.

Now you can earn 5% on bonds but stay with quality

Conservative investors who want the greater capital security of bonds can now lock in 5% but they should stay at the higher end of credit quality. Rises in rates and defaults mean it's not as easy as it looks.

30 ETFs in one ecosystem but is there a favourite?

In the last decade, ETFs have become a mainstay of many portfolios, with broad market access to most asset types, as well as a wide array of sectors and themes. Is there a favourite of a CEO who oversees 30 funds?

Betting markets as election predictors

Believe it or not, betting agencies are in the business of making money, not predicting outcomes. Is there anything we can learn from the current odds on the election results?

Meg on SMSFs – More on future-proofing your fund

Single-member SMSFs face challenges where the eventual beneficiaries (or support team in the event of incapacity) will be the member’s adult children. Even worse, what happens if one or more of the children live overseas?

Latest Updates


'It’s your money' schemes transfer super from young to old

Policy proposals allow young people to access their super for a home bought from older people who put the money back into super. It helps some first buyers into a home earlier but it may push up prices.

Investment strategies

Rising recession risk and what it means for your portfolio

In this environment, safe-haven assets like Government bonds act as a diversifier given the uncorrelated nature to equities during periods of risk-off, while offering a yield above term deposit rates.

Investment strategies

‘Multidiscipline’: the secret of Bezos' and Buffett’s wild success

A key attribute of great investors is the ability to abstract away the specifics of a particular domain, leaving only the important underlying principles upon which great investments can be made.


Keep mandatory super pension drawdowns halved

The Transfer Balance Cap limits the tax concessions available in super pension funds, removing the need for large, compulsory drawdowns. Plus there are no requirements to draw money out of an accumulation fund.


Confession season is upon us: What’s next for equity markets

Companies tend to pre-position weak results ahead of 30 June, leading to earnings downgrades. The next two months will be critical for investors as a shift from ‘great expectations’ to ‘clear explanations’ gets underway.


Australia, the Lucky Country again?

We may have been extremely unlucky with the unforgiving weather plaguing the East Coast of Australia this year. However, on the economic front we are by many measures in a strong position relative to the rest of the world.

Exchange traded products

LIC discounts widening with the market sell-off

Discounts on LICs and LITs vary with market conditions, and many prominent managers have seen the value of their assets fall as well as discount widen. There may be opportunities for gains if discounts narrow.



© 2022 Morningstar, Inc. All rights reserved.

The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.