What held REITs back in the past few years, according to Sahn, was the impact of higher interest rates. Real estate generally holds a high degree of exposure to interest rate increases, given the use of debt to purchase, upgrade, or build properties. Investors shied away from REITs because they expected the high interest rate environment would weaken REIT fundamentals.
That was perhaps most obvious in the case of office REITs, which have struggled to recover from the impact of the COVID-19 pandemic and the sudden shift towards widespread remote work. Valuations have come off, liquidity has dried up, and the price of debt has made investors more wary. Office, Sahn says, has become the poster child for the broader REIT market. However, he thinks that the underperformance in office has hidden a broader property market that’s been more resilient than many investors expected.
In the US and — to a lesser extent — Canada, economic resilience has been a watchword for the past few years. While cracks are beginning to show more meaningfully now, we have seen both economies hold in stronger than anticipated given the pace of interest rate increases. While Sahn acknowledges the cracks forming now, he puts weaker employment numbers in the context of historical norms to note that we have not deviated far from average levels. That weakening, though, sets the stage for the comeback that Sahn predicts, because central banks are now cutting rates.
The Bank of Canada has already cut its overnight rate by 0.5 per cent and is predicted to deliver at least another 0.25 per cent cut in its September meeting. The US Federal Reserve is all but guaranteed to make its first cut at its September meeting. Lower borrowing costs offer tailwinds for REITs and shift investor appetites. The start of a cutting cycle, Sahn argues, should be the inflection point for these assets.
Looking at specific opportunities in North American real estate now, Sahn is particularly bullish on a few property types. Senior housing, which includes assisted and independent living facilities, has long been an area where he sees growth. Supported by demographics in the form of aging baby boomers, Sahn sees a huge ongoing uptick in demand for these properties.