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There has been a pullback in the global REIT market over the last couple months, especially in the U.S.

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The good news is this has created an opportunity to buy good companies at lower valuations, says Chip McKinley, senior vice-president and portfolio manager with Cohen & Steers in New York. Among other real estate funds, he manages the Renaissance Global Real Estate Fund.

“Most [REIT] markets have pulled back in a fairly well-coordinated fashion, but it’s been particularly hard in the U.S.” One reason for this, says McKinley, is “the returns [for] U.S. REITs year-to-date had been amongst the strongest globally since February lows. These richer valuations made them more susceptible when sentiments started to turn against capital markets and yield-sensitive investments.”

McKinley and his firm were bearish when it came to U.S. REIT allocation, but that has changed. “As the valuations soared in the U.S., we became more critical of our ability to create alpha there,” he explains. “So we’ve been selling the U.S. [and] we’ve been very underweight. But now that they’ve pulled back by [about] 7% to 9% […], [REITs] look a lot more reasonably priced.”

Read: REIT analysis tips from equity and bond managers

The main reason for the decline in REIT valuations, says McKinley, is there has been a rise in interest rate and inflation expectations across the globe.

“Historically speaking, whenever you see a spike in interest rates, that causes a near-term sell-off in REITs.” But, when spikes in interest rates are accompanied by increases in inflation and growth expectations, that makes it a great time to buy, he adds. “We’ve seen this pattern over and over again.”

Read: 3 ways to tap into real assets

McKinley says there’s a positive correlation between stronger REIT performance and these types of rate-hike environments because of the possibility for higher cash flows over the long term.

“This is because [the conditions that are] driving interest rates higher are the very same [conditions] that will ultimately drive cash flows higher in REITs. In other words, higher expectations for inflation, which [means] higher prices and, in part, higher rents. It’s exactly what is pushing yields up and pushing yield-sensitive instruments down.”

But markets and investors don’t see this upside right away, McKinley adds, because “it takes months and even quarters for real estate companies to start capturing the benefits of higher prices in the form of higher rents.”

He suggests, “[When] you see a sell-off like this, […] that’s your opportunity to buy companies and wait for the higher cash flows to come in over the next several quarters.”

Read: Homes of the future and how much they’ll cost

McKinley has kept his eye on U.S. and global REITs. “Where we’ve been positioned the last few months are areas that, by-and-large, we see better growth at the property level […] And, predominantly, we’ve tended to see [this] in higher-growth markets [that have] very attractive monetary policy, and good growth and supply dynamics.”

He sees opportunity in Germany and, to a lesser extent, in Australia and the United Kingdom. “We’re seeing good recovery and demand growth for offices in every one of those countries. Meanwhile, new supply is almost non-existent and you’ve got very supportive central bank policies. They’re all trading very cheaply.”

Read:

ETFs rebalance as REITs become sector 

Take advantage of real asset price gaps

Originally published on Advisor.ca
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