Property shares: ripe for a comeback?

Property shares were in strong demand for many years. When interest rates rose, crowds of investors pushed the sell button. Is there an improvement on its way? A helpful interview with Gert De Mesure, an independent analyst specialising in property shares.

Anyone who has had property shares in their portfolio in recent years was not happy about it. Why is this?

"In the years before the coronavirus crisis, real estate was a popular sector for investors. In particular, large institutional investors, such as pension funds and insurers, bought plenty of stock exchange listed property," says Gert De Mesure. "Since interest rates were very low or even negative, there was hardly any return to be had from bonds. Property shares traditionally yield attractive dividends, tend to be defensive and so offered a good alternative for those who wanted a relatively stable income. A bond with an annual coupon of 0.2% or a property share with a dividend of 4%? Many investors were happy to take on the associated equity risk."

"The rises in interest rates in 2022 and 2023 completely turned the tide. As a result, bonds and other fixed income products made an unprecedented comeback. By way of comparison, in the second decade of this century, long-term interest rates took 6.5 years to fall from 3% to 0%. In recent years, long-term interest rates have only taken 1.5 years to rise from 0% to 3%," he explains. "The magnitude and speed of the rate hikes were therefore immense. Institutional investors quickly swept out their (more risky) property shares, and brought in (less risky) bonds or other fixed-income investments."

"Of course, we must not forget that property shares are "shares" first and "property" second. Anyone who can buy a property on the real estate market at 40 per cent below the estimated value uncorks the champagne. But that’s not how it works on the stock exchange. Equity markets are much more sensitive to interest rate changes and are driven by 1001 different factors. In addition, these are property companies; they are not just buildings. Once property is listed on the stock exchange, it also takes on the characteristics of the stock market and follows market dynamics. If the stock market crashes 30% tomorrow, property shares will probably also crash, even if their results were not even being affected."

Nevertheless, company results in the sector remained generally good, despite rising interest rates?

"Indeed, yes. Although share prices fell sharply, the figures remained relatively good. Rental income was indexed and remained stable. Occupancy rates generally remained stable. And a large proportion of the companies had hedged against rising interest rates," says Gert De Mesure. "Then of course, suddenly there was competition from bonds. The fact that property shares were sold off cheap was mainly the result of rising long-term interest rates." "Mainly, but there is one other reason why investors pressed the sell button. More and more questions were also being asked about the high levels of borrowing at some property players, and their sustainability," he says. "This is how it works. Most private individuals in our country choose a fixed interest rate when they buy real estate. In other places, and for commercial transactions, a variable interest rate is the norm. For years, property companies – just like private individuals – had access to cheap finance. The lower interest rate made it particularly attractive for them to invest in new projects. But because interest rates have risen in the meantime, and the interest that companies pay is regularly reviewed, interest costs at many property companies have now also increased."

"This problem can be seen clearly in Sweden, for example. There are a lot of property companies stuck with a noose around their necks because interest rates rose suddenly," he explains. Fortunately, most property players in Belgium are well hedged against interest rate rises, so they are less exposed to this issue. Nor is there is a real estate crisis in Belgium. There is not a significant level of vacancies, and rents are rising. At worst there is a financing crisis."

Gert De Mesure

What might a turnaround bring?

"For this you mainly need to look at the trend in long-term interest rates. It can be seen very clearly in the rates: any day that central banks are predicting a rate cut is a day when property shares are doing (exceptionally) well," he points out. "Apart from long-term interest rates, business-related factors also play a role, and these make one property company more vulnerable than another. But I expect that it will be primarily the interest rates that will dominate property share prices for at least the next six months."

For the time being, everything indicates that interest rate cuts are coming, although with some delays. Is today a good time to buy in?

"Yes, in some places. But don't expect miracles. The European Central Bank’s key rate is currently at 4% (as of April 2024). Let’s say it drops to 3%. That 3% is still much higher than in 2019, when interest rates were still negative (-0.5%). If a property share had a price of EUR 40 in 2019, and has a price today of EUR 25, then you should not assume that the price will climb back to EUR 40. There is upside potential, but the situation is completely different today to what it was back then. You should also take into account that property companies that are hedged against interest rate rises will not remain hedged forever. Sooner or later, they too will have to refinance their borrowing at a higher interest rate. And once again: don't forget that property shares are facing strong competition from bonds and other fixed income products. Many institutional investors have sold off their property shares in recent years, and may have no intention of returning to them any time soon."

So anyone considering buying in, would do well to be selective?

"Yes. Take the Cofinimmo share as an example. This currently generates a net dividend of 7.5%. That’s not be sneezed at. With an occupancy rate of 98.5% and predictable income, the share looks solid, while it costs half as much as it did three years ago. As an investor, you might ask yourself: what are you risking if you know that the results will likely remain stable, the risk is probably moderate, and the dividend is attractive?" he wonders. "If you see how a handful of US companies dominate a large part of the stock market indices, that seems to me to be a more significant (concentration) risk. So property shares definitely deserve a place in a diversified portfolio."

Are there any particular segments or regions that look attractive?

"We may be a bit chauvinistic: Belgian property shares look attractive. They currently have low valuations. Belgian property shares have historically always been more expensive than their European peers due to their solid history of growth. That premium has partly been lost, which also makes it interesting to consider them today."

"Looking at segments, logistics real estate, healthcare real estate and retail real estate are particularly attractive. Logistics real estate because rental income has been rising well for several years – in the past, it only increased with inflation, and sometimes landlords were even willing to freeze it. Retail real estate, on the other hand, has the lowest value today, due to concerns about e-commerce. Nevertheless, retail properties are relatively robust and investment costs can be passed on. Thanks to a few bankruptcies and aberrations at a handful of healthcare property players, the market is still somewhat wary of this sector. Nevertheless, the impact on its rental income remained limited. The low valuations of healthcare real estate also offer great potential."

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