Warning on Reits as gilts rise

Warning on Reits as gilts rise
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Real estate investment trusts look 'less attractive' following the rise in government bond yields over 2022, a senior research analyst has warned.

Chelsea Financial Services' James Yardley said while the company generally liked Reits, the consensus among the team was they "look at lot less attractive" now than they did before gilts were pushed higher following a series of bank base rate hikes.

Yardley explained: "This has had a doubly negative effect on Reits. Firstly opportunity cost: if you can get 4 per cent on a government bond why bother with a much more risky Reit yielding 5 per cent?

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"They looked a lot better relative value when government bond yields were 1 per cent."

As James Johnson of Church House Investment Management told FTAdviser earlier, the rapid rise in the bank base rate to combat eye-watering inflation has proved beneficial for cash and gilt investors. 

He said: "Cash deposits are already attracting interest of 4.5 per cent. Annuity rates for pensioners and retirees, for so long pinned down by low gilt rates, have soared with about 6 per cent plus guaranteed annual returns on offer."

But for Yardley, this has taken the shine off Reits.

The second concern for Chelsea Financial Services is the cost of debt for Reits as we head into 2023.

He explained: "The cost of debt for Reits will now be a lot higher. This makes it much harder for them to gear up to earn extra income and also poses a big refinancing risk for Reits, which don’t have long term fixed debt."

This could also pose a risk to many Reits' dividends, some of which may needed to be cut.

"Of course, a lot of this has been reflected in the big increase in discounts that many Reits are trading on. But some of these discounts are illusions as there is a delay before Navs are marked down.

"So there are some opportunities, but investors need to be very careful and selective. We generally prefer specialist Reits rather than diversified", he added.


Yardley's comments came in reaction to news yesterday (Monday 6) that real estate funds, investment trusts and real estate unit trusts have been showing some stellar performance over the past 12 months.

According to the Association of Real Estate Funds, many of the composite funds in its index have returned far above the 11.1 per cent inflation rate that was reported in November. 

The AREF index found the average performance return (calculated in percentage change over the past 12 months) has been an average Nav of 1.3mn, with the average residential fund having seen growth of 11.1 per cent on an annual basis.

However, the gating of several commercial property unit trusts has put some advisers off using open-ended property funds and turning to investment trusts such as Reits.