Real Estate Investors Eye REITs as Interest Rates May Drop
Amidst growing expectations of interest rate cuts, real estate is gaining attention among investors. The market is betting that this month’s inflation data will give the Federal Reserve the green light to lower rates, a move that could benefit the real estate sector. This expectation is fueled by the belief that real estate investment trusts (REITs), which are assets tied to real estate, thrive in low-interest rate environments. This is because many REIT investments involve leverage and borrowing, so lower rates mean lower borrowing costs and a more attractive investment due to higher rental income yields. Though there’s no guarantee of success, REITs could perform well even with higher interest rates, as the extent of borrowing costs depends on factors like debt loads and industry.
Key Takeaways:
- Real estate is attracting investor attention due to potential interest rate cuts.
- REITs, assets linked to real estate, are expected to benefit from lower interest rates.
- Lower interest rates lead to lower borrowing costs and higher rental income yields.
- Experts remain optimistic about the office sector, highlighting the growing demand for high-quality office spaces.
- Morningstar suggests Kilroy Realty as a potentially undervalued REIT with high yields and a focus on the tech and life sciences sectors.
Morningstar Highlights Kilroy Realty as a "Cheap" REIT
Morningstar, a renowned financial research firm, is bullish on Kilroy Realty, a U.S.-listed REIT, as a compelling investment opportunity. Suryansh Sharma, an equity analyst at Morningstar, cites the REIT’s "cheap" valuation and high yield as key attractions. In a July report, Sharma stated that Kilroy Realty holds a prominent position in the burgeoning life sciences sector, with significant exposure in its portfolio and development pipeline. He highlighted the REIT’s strategic focus on premier offices, mixed-use properties, and assets related to the tech and life sciences industries, particularly in major U.S. cities.
The Rise of Hybrid Work and Office Demand
Sharma acknowledges the growing acceptance of remote and hybrid work solutions, but emphasizes that offices will remain central to workplace strategies. He predicts a rise in office use over time, leading to a recovery in demand for office real estate.
Kilroy’s Growth Trajectory
Morningstar forecasts a 0.9% compound annual growth rate in average rent per square foot for Kilroy’s portfolio over the next decade. Sharma also highlighted the REIT’s substantial development pipeline, projecting yields around 6.50% through 2033, which will contribute significantly to the company’s valuation.
A Focus on Technology and Life Sciences
Sharma underscores Kilroy Realty’s strategic focus on technology and life sciences markets, which he expects to yield long-term benefits. High-quality office buildings with good amenities are expected to benefit from the "flight-to-quality trend" in the office sector.
Kilroy: One of the Most Undervalued REITs
Morningstar’s chief U.S. market strategist, Dave Sekera, labels Kilroy Realty as one of the most undervalued REITs under their coverage. He highlights the firm’s strong tech sector focus, noting that tech employment has been steadily growing. Sekera emphasizes the return to office mandates by major tech companies like Apple, Alphabet, Amazon, Meta, and others, requiring employees to return to at least a hybrid work schedule with three days a week in the office.
A Younger Life Science Portfolio
Sekera further points out that the buildings in Kilroy’s life science portfolio are relatively young, with an average age of just 11 years, significantly younger than many peers. This is expected to contribute to better occupancy rates.
The Remote Work Dynamic: A Key Risk
While optimistic about the future of office real estate, Sharma acknowledges the ongoing remote work dynamic as a significant risk for the sector. He emphasizes that the pandemic demonstrated the capabilities of technology in enabling employees to collaborate and maintain productivity remotely. This has led to the increasing prevalence of hybrid workplace policies, presenting a major challenge to future office demand.