REITs poised for rebound with strong rental growth and shortage of supply

Annabel Brodie-Smith, Communications Director of the Association of Investment Companies (AIC), said: “Only last week we saw yet more acquisitive activity in the REITs sector, with Tritax Big Box REIT gazumping US giant Blackstone with a £485 million offer for Warehouse REIT. This type of M&A activity is just one of the ways that shareholders could benefit from the ongoing property revival and its impact on the REITs sector.”

Is now a good time to invest in UK REITs?

Kenneth MacKenzie, CEO of Target Healthcare REIT, said: “Yes. Many are trading at significant discounts to their net asset value, offering investors the chance to acquire real estate below its true value. This gap reflects past market headwinds, including high interest rates and sector-specific pressures. But with expectations of rate cuts from the Bank of England later this year, sentiment is starting to improve. If interest rates ease and yields become more attractive relative to other income assets, REITs with strong balance sheets could deliver income whilst share prices rise.”

Richard Shepherd-Cross, Investment Manager of Custodian Property Income REIT, said: “UK REITs are poised to deliver consistent and growing returns. In a world full of geopolitical noise and macro market drivers, investment in domestically focused UK real estate, with contractual income from a diverse range of tenants, offers a safe haven for investors.

“Following the rise in interest rates from 2022, commercial property values fell, but returned to growth in the summer of 2024, growth which has persisted over the last 12 months. This growth has not been driven by yield compression (capital growth), but by underlying rental growth. With further rental growth to come, the window of opportunity to invest in UK REITs at an opportune time remains wide open for investors who have so far been slow to react to the improving prospects for UK real estate. Many REITs continue to trade at wide discounts to NAV. I do not believe that current ratings reflect the true worth of the REITs, where it remains possible to buy in at share prices reflecting dividend yields of 5% to 7.5%, with those dividends fully covered by the earnings of the company.”

Marcus Phayre-Mudge, Fund Manager of TR Property Investment Trust, said: “It’s a good time to invest in UK REITs, albeit selectively. The surface of the pond is extremely choppy right now. Volatility in broader markets, fuelled by geopolitics and interest rate uncertainty, has made it hard for investors to get a clear read on real estate. But if you look beneath the surface, real estate fundamentals are in far better shape than most people realise.

“What’s been quietly unfolding is the payoff from over a decade of underdevelopment. The roots of this go all the way back to the global financial crisis, when banks – which had traditionally provided speculative development finance – largely exited the market. Since then, we've had a remarkably subdued development cycle, particularly in key urban markets. As a result, we’re now facing a supply shortage in most sub-sectors, especially for high-quality space in the right locations. That imbalance is pushing rents up – sometimes dramatically so. Combine that with easing rate expectations, access to more attractively priced, long-dated debt, and REITs with solid balance sheets and low leverage, and the setup looks very favourable.”

Laura Elkin, Portfolio Manager of AEW UK REIT, said: “We feel that now is a very good time to invest in diversified UK REITs as average UK commercial property values are at their lowest level since 2015. We are very excited by the attractive fundamentals that our current pipeline presents and believe there is a strong opportunity to replicate the outperformance that our strategy has consistently achieved over the past ten years across a larger portfolio of assets.”

What will drive returns over the coming year and beyond?

Marcus Phayre-Mudge, Fund Manager of TR Property Investment Trust, said: “It’s a bit of a cocktail. Falling or stabilised interest rates are helping open up bond markets again, rents are growing, particularly in prime sectors where there’s a fundamental shortage of space –logistics, centrally located offices, quality retail. Then there’s a flurry of M&A activity going on in the listed space, particularly among the smaller externally managed trusts. That’s unlocking value, and investors are starting to cotton on. But really, it all comes back to that rather boring but essential equation: supply and demand. If you own the right kit in the right place, you’ll do well.”

Richard Shepherd-Cross, Investment Manager of Custodian Property Income REIT, said: “Mergers and acquisitions have the potential to take out those REITs which have been trading on the widest discounts to NAV and in so doing improve the prospects of share price recovery across the REIT universe.

“However, the principal driver of return will be income and income growth. In our own portfolio, Custodian Property Income REIT has seen valuations grow in line with rental growth, while yields have remained stable. Short-term interest rates will offer some additional earnings headroom but given the stubbornly high ten-year gilt rate, which is so closely correlated to property valuation yields, I would not forecast significant yield compression. However, double digit total returns remain entirely possible.”

Laura Elkin, Portfolio Manager of AEW UK REIT, said: “For the right assets in the right location, we see robust tenant demand which is expected to drive pockets of rental growth. We believe that this, combined with normalising investor demand as interest rates fall, will drive a recovery in values. However, not all market subsectors are expected to react as strongly as others, and as performance within some submarkets becomes increasingly polarised, we believe in careful stock selection that considers the sustainability of both income and capital returns.

“Within AEW UK REIT, our sector agnostic approach has led us to buy and sell between commercial property sectors as pricing fluctuates. This, combined with current low investment volumes across the market, creates an opportunity for our strategy to benefit from the mispricing that we expect to continue and which will help to drive the company’s outperformance.”

Should REITs be considered for income, capital growth, or both?

Laura Elkin, Portfolio Manager of AEW UK REIT, said: “REITs should absolutely be considered for both income and capital growth. Taking AEW UK REIT as an example, the company delivers one of the highest dividends in the investment trust sector and has achieved double digit total returns from both our NAV and share price over one year and on an annualised basis over five years. This strong performance has been driven by a combination of our value investment strategy and active asset management which maximises both income and capital returns.”

Marcus Phayre-Mudge, Fund Manager of TR Property Investment Trust, said: “I’d say REITs are for both income and growth, but with a clear emphasis on income. What really matters for REIT investors is a company’s discipline in paying dividends out of earnings. Over a full cycle, roughly 80% of REIT returns come from dividends. Many of the REITs I look at yield between 5% and 7%, with capital appreciation a nice cherry on top. Income is king here, and that dependable dividend is what draws many investors in – it’s the rock-solid anchor in an often turbulent market.”

Richard Shepherd-Cross, Investment Manager of Custodian Property Income REIT, said: “Property has often been seen as a good hedge against inflation and following the first bout of serious inflation for many years, the property market is reacting with strong rental growth. This rental growth will protect the real value of the £1 invested in delivering growing dividends and capital growth.

“REITs offer short income returns (currently 5% to 7.5%), longer-term income growth and capital growth in inflationary times. As with all investment, timing is important to capture capital growth, but with property valuations close to the recent bottom of a cycle, shares in REITs trading at a discount and ongoing rental growth, the timing feels right.”

Bradley Biggins, Fund Manager at Schroder Real Estate Investment Trust, said: “This is an interesting time for UK real estate. Following a 25% correction to average commercial real estate values there is an attractive income return available. For example, Schroder Real Estate Investment Trust (SREI) offers a fully covered dividend yield of around 7%, and we expect continued rental growth as there is a thin pipeline of development projects given the level of construction costs following high inflation, and there is a shortage of quality space with strong sustainability performance that occupiers are favouring.

“Structurally supported sectors such as multi-let industrial estates and convenience led retail warehouses will benefit most, and these represent 63% of the SREI portfolio. There has only been modest capital value growth since the correction, so rental growth combined with modest yield compression as we progress through an interest rate cutting cycle should support capital values and combined with an attractive income return, will result in above average total returns in the coming years.”

Kenneth MacKenzie, CEO of Target Healthcare REIT, said: “UK REITs should be considered for both income and capital growth, but primarily for their income potential. They typically offer attractive and relatively stable dividend yields, making them a reliable source of income for investors. Over time, as rents increase, investments will grow. However, the main appeal remains the consistent cash flow. For investors looking for a balance of income with the potential of extra growth, REITs contribute to a diversified portfolio.”

What are the key risks facing REIT investors today?

Bradley Biggins, Fund Manager at Schroder Real Estate Investment Trust, said: “Many REITs have looming debt refinancings which could have a material adverse impact on earnings given the base rate is some 4% higher than when many existing facilities were agreed. We note the majority of our trust’s debt is fixed at an average of 2.5% for 11 years which is a fantastic advantage in a higher rate environment. There is also a risk REITs are acquired by opportunistic private capital for less than their intrinsic value.”

Marcus Phayre-Mudge, Fund Manager of TR Property Investment Trust, said: “The long end of the bond market is still a bit of a question mark – and we’ve got to be realistic that geopolitical risks or inflation surprises could send yields up again. That affects valuations. Then there’s the risk of owning the wrong type of real estate. A 1990s office park outside Swindon, where you need a car to get in and out and there’s nowhere to get a coffee? That’s not what tenants want anymore. They want to be in city centres, close to public transport, with proper end-of-journey facilities – bike racks, showers, somewhere to stash your Amazon parcels. Scale matters too: smaller trusts with limited liquidity are increasingly out of favour.”

Kenneth MacKenzie, CEO of Target Healthcare REIT, said: “The key risks facing REIT investors today stem from the broader macroeconomic environment. Rising bond rates can make REIT dividends less attractive compared to more stable income investments, potentially reducing demand.”

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