Global Mizuho Report Addresses REIT Bubble Concerns: Sparkling But Not Too Bubbly

October 24, 2016

Real estate has outperformed other markets in recent years, which has simultaneously raised celebrations and concerns, all the while begging more than a few questions. Where might there be bubbles? How much yield is really up for grabs? What is the best way to invest effectively given my risk tolerance?

Mizuho addresses these concerns head-on by analyzing four major global markets – the US, Japan, Hong Kong and Singapore – to deliver a comprehensive examination of the global REIT marketplace, including any bubbles, opportunities and pitfalls for investors to avoid.

In the first report of its kind, global Mizuho analysts Richard Anderson, Haendel St. Juste, Yosuke Ohata and Alan Jin, Ph. D., developed a comprehensive REIT investment guide to set the facts straight in one of the most discussed and misinterpreted sectors. 

Rates as a Driver for REITs
What drives the REIT market? As an asset class, REITs stand at a unique place in the economy, influenced by interest rates and yield spreads, as well as policy decisions by the Fed and BOJ, in particular.  

While at the mercy of macroeconomic forces, REITs have notably performed similarly or better than equities over extended periods of time. For example, “during the 10 years to June 30, 2016, the S&P Global REIT Index returned 6% annualized, compared to just 2.1% for the MSCI EAFE Index of developed-country equities and 7.4% for the S&P 500 Index,” writes Financial Advisor Magazine

The Mizuho analysts agree that “REITs are performing well globally.” So what are the central forces driving market performance? “We think a key reason is a REIT market tailwind from global flows of funds into high-yield assets in this prolonged period of low interest rates,” they write.

US Outlook Strong
For some, the party appears to have gone on too long. Mizuho acknowledges the legitimacy behind this concern, but a regional breakdown of the market sheds light into areas that may be bubbling versus those as flat as an undeveloped cityscape. 

“While it is hard to deny that the US real estate cycle is in the late innings of the current cycle, US real estate fundamentals remain favorable today evidenced by full occupancies, favorable demand and above-average organic growth rates,” write the analysts.

In other words, the US market shows only a minimal risk of bubbling due to the endurance of attractive relative spread between investment cap rates and cost of capital.

While bubbles do not pose an imminent risk for the US, rate volatility may alter the landscape – and returns – quite a bit. “Once interest rates return to more normal long-term levels, investor focus will shift from external (non-real estate) considerations, to a real estate fundamental approach based on a more conventional supply/demand analysis,” the report concludes. “At that point when we think US asset values could face pressure as the crutch of low interest rates is removed from the equation.”

Investors in US REITs also have local factors to consider for their optimal investment portfolio. A few areas of fundamental concern include Houston, New York and San Francisco. On the other hand, Los Angeles and Seattle continue to present bright spots. Even the all-important Washington, D.C. market appears to be slowly turning the corner after an extended period of decline. 

Asia Sparkling
In comparison with the US, the outlook is a bit more effervescent for other areas of the world.

In Japan, the REIT outlook is stable. “The data indicate that the [Japanese] market is not in a bubble—meaning that rents are not rising beyond the long-run trend line,” Mizuho reports. “In terms of the longer-term cycle, we believe the real estate market is currently between the mid-point and the later stages of a recovery phase.”

Meanwhile, parts of Hong Kong and Singapore show signs of distress. 

For China in particular, concerns are high. “The rally in China’s housing market implies significant risks for the future. With the newly eased liquidity, which should reach lower-tier cities according to policy intention, we see the price run-up in tier-1 cities as a clear bubble.”

For investors looking at REIT opportunities in Asia, the landscape is divided with Japan on the rise and Singapore/Hong Kong riddled with potential pitfalls. This doesn’t render the entire region a bad bet, however. That will depend on your desire for yield and, mostly importantly, resistance to risk. 

A Game of Risk and Reward
At the end of the day, the right REIT investments will depend on your risk tolerance. In this sense, Mizuho recommends investors put themselves squarely in one of two camps. 

For investors with a high risk tolerance, being overweight in Asia including Japan is your best bet for yield. Meanwhile, those with an easily upset stomach should stick with the US market for smoother, but perhaps less profitable, sailing.

Grabbing yield in the current interest rate environment is tough. Mizuho Americas chief economist Steven Ricchiuto recommends investors “put new money to work in the highest yielding asset an investor feels comfortable holding given their risk tolerance.” In REITs, this is a particularly critical factor given the diverse spread of opportunities out there. 

For investors of all stripes, REITs can be a great tool – just make sure to mind your bubbles and your borders. 

Simon Hylson-Smith

CEO, Paragon

Simon Hylson-Smith is a former financial industry editor and currently CEO of Paragon.

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