CPI Less food & energy: year-on-year change
Source: Greensteet Research June 2021
The FED expects a transitory uptick in inflation above target rate in the short term due to supply-chain dynamics and the reopening of the economy. Historically, Global REITs have proven to be a decent inflation hedge with average total returns during the eight inflationary spikes being 24%, relative to the S&P 500 (15%) while also outpacing inflation (11%). More impressive is the 13% annualised total return US REITs generated during the decade that commenced in 1973 in which inflation rose 8%/yr. Stocks and bonds did not keep pace with inflation during that period.
Source: Nareit Midyear 2021 Economic Outlook; FTSE Nareit All Equity REIT Index and S&P 500 Index; 1972-2020
Refer to our Global dashboard for further insights into inflation and the impact on global REITs.
Global Dashboard – Q2 2021
Locally, SA annual inflation climbed above the 4.5% midpoint of the South African Reserve Bank’s monetary policy target range, accelerating to 5.2% in May 2021 from 4.4% in the prior month. This is the highest reading since November 2018 when the rate was also 5.2%.
Historically, the income return from property has been relatively stable with volatility in total returns emanating from the capital component. Due to lockdown restrictions, tenant relief, bad debt increases and general uncertainty, the income return from property has come under pressure as available earnings have diminished and companies endeavour to retain cash through dividend deferrals and the implementation of pay-out ratios. Despite the diminished income return of 4.4% in 2020, it remains above the average inflation figure which was recorded at 3.2% for 2020. In this regard, real estate’s income component remains an effective inflation hedge.
Source: Bloomberg, Catalyst Fund Managers, 30 June 2021
Source: Stats SA, Bloomberg, Anchor Research Catalyst Fund Managers, Property – SA Listed Property Index (J253T), Equites – All Share Index, Cash– Stefi, Bonds – All Bond Index *High inflation periods where average inflation >7%, Data set 1995-2021
In the above graph, we compare SA listed property returns to other assets classes. There are two major periods of high inflation in the sample where SA listed property outperformed the ALSI. During 1995-2002 inflation averaged 7.11%, SA listed property total returns outperformed other asset classes barring bonds, with average returns of 14.97%, whilst the ALSI returned 9.45%. Between 2007-2010, SA listed property total returns outperformed all asset classes by an average of 6.52% with total returns of 15.62%. While past returns are no guarantee of future performance, SA listed property has proven to be resilient through separate periods of high inflation.
According to the World Bank, global inflation is anticipated to continue to rise over the rest of the year; however, it is expected to remain within the target range for most countries. While REIT earnings have traditionally had a strong correlation to inflation, this relationship is likely to breakdown in the short term due to the current COVID-19 environment and the reduction in pay-out ratios to more sustainable levels. Over the long-term however, we think REIT earnings will continue to exhibit strong hedging characteristics against rising inflation due to inflationary contractual escalations embedded in most lease structures. The value of real estate is determined by multiple factors such as net income, capitalisation rate and the demand and supply dynamics affecting each subsector. Inflation is just one of many variables that affect its value along with other macro-economic factors. Incorporating an inflation-hedging asset into a portfolio is no free lunch, as it may increase a portfolio’s risk profile. Although REITs have desirable inflation-hedging properties, consideration needs to be given to the impact they will have on the overall volatility of a diversified portfolio and the correlation to other asset classes.