How REITs work

REITs are listed securities that own, operate and/or finance income-generating real estate. They are bought and sold in the same way as shares. 

REITs can provide investors with immediate exposure to a large-scale property portfolio that can include office towers, hotels, warehouses and shopping centres, with the added benefits of liquidity, transparency and regulation associated with investing in publicly traded stocks through an exchange, such as ASX.

For investors, a key attraction of REITs is their potential for higher dividend yields compared to other listed equities. Many REIT subsectors, such as industrial or office property, feature revenue streams that are indexed to inflation. For instance, rental agreements for factories and office spaces typically include inflation-linked adjustments [the rent goes up each year in line with inflation].

Additionally, some property subsectors, such as healthcare and residential real estate, may be less sensitive to economic cycles. These assets are vital to society, ensuring demand might remain steady even during economic downturns. This feature reinforces the role of REITs as a potential diversification tool for investment portfolios.

Investment features

REITs, particularly Australian REITs (A-REITs) listed on ASX, are well known to many local investors. However, limiting exposure to the Australian market can potentially mean missing out on opportunities overseas for diversification and returns.

At end-December 2024, A-REITs accounted for just 6.3% of the global listed real estate market, which is valued at US$1.5 trillion, based on the FTSE EPRA Nareit Global REITs index (referred to hereafter as ‘the international index’). 

While the Australian REIT market, valued at US$97 billion in the international REIT index [1], provides exposure to sectors such as retail and office properties, it lacks the breadth of subsectors seen globally. 

Recently, the S&P/ASX 200 A-REIT index has become noticeably concentrated with the data-center and industrial property owner, Goodman Group (ASX: GMG)  comprising more than 43% of the index [2].
 

Chart 1: Australian versus international REITs subsector comparison 

Source: VanEck, Factset. Data to 31 December 2024. International REITs is FTSE EPRA Nareit Developed ex Australia Rental Index AUD Hedged; Australian REITs is S&P/ASX 200 A-REIT Index.

Four of the top 10 REITs in the international REIT index either specialise or invest heavily in data centres. This includes firms such as Equinix and Digital Realty Trust [3].

The expansion of cloud computing and artificial intelligence may lead to a rise in demand for global data centres. As businesses and societies increasingly depend on machine learning and advanced computing, global real estate services company JLL predicts global data centre capacity will increase by 15% per year. 

Similarly, healthcare REITs, which encompass hospitals, aged-care facilities, and medical offices, may experience less elastic demand. VanEck’s view is that with ageing populations and the ever-present need for medical care, the healthcare property subsector is positioned for long-term growth. However, there are few healthcare REITs in the local A-REIT sector.
 

Chart 2: Performance of Australian REITs versus Global REITs in 2024

Source: VanEck Australia, Bloomberg, January 2025. G-REIT unhedged is FTSE EPRA Nareit Developed ex AUS Rental in AUD Unhedged Index, G-REIT hedged is FTSE EPRA Nareit Developed ex Aus Rental in AUD Hedged Index and A-REIT is S&P/ASX 200 A-REIT (Sector) Total Return Index. You cannot invest in an index. Past performance is not indicative of future performance.

How interest rates affect REITs

The concept of duration is critical in understanding how interest rate changes impact both A-REIT and global REIT valuations. Duration measures the sensitivity of valuations to shifts in interest rates— longer durations amplify these effects. 

Because REITs primarily hold property investments with long-term lifespans, fluctuations in yields significantly affect both their valuations and the present value of future earnings. 

When the US government 10-year bond yield declines, global REITS have historically outperformed, underscoring the importance of interest rate trends in shaping REIT investment opportunities, as Chart 3 below shows.

Sell-side consensus forecasts (the average of analyst forecasts) are for a 0.5% decline in US 10-year yield, reaching 4.15% by year-end [4] . If that forecast materialises, lower interest rates could potentially act as a tailwind for global REIT performance.
 

Chart 3: Global REIT relative performance versus US 10-year government bond yield

Source: VanEck Australia, Bloomberg, January 2025. You cannot invest in an index. Past performance is not indicative of future performance. REIT Index refers to FTSE EPRA Nareit Developed ex Australia Rental Index AUD Hedged.

Bull case for REITs

Looking ahead, the potential for a global monetary easing cycle presents a more favourable outlook for REITs, in VanEck’s opinion. 

Lower interest rates reduce borrowing costs for REITs, improve financing conditions, and can lead to higher property valuations. Markets are already pricing in one to two rate cuts of 0.25% from the US Federal Reserve for 2025 [5]. 

VanEck’s view is that offshore REITs are poised for growth in 2025, driven by organic expansion, a recovery in commercial real estate (CRE) transactions, and selective opportunities despite rising refinancing costs. 

According to Morgan Stanley Research and Real Capital Analytics, the CRE transaction market is projected to grow year-over-year to US$450 billion, fuelled by stabilised property prices across apartments, retail, and industrial assets, along with easing lending standards highlighted in the US Fed’s October 2024 survey.

Bear case for REITs

Debt refinancing, however, poses a potential headwind for REITs, with Morgan Stanley/Real Capital Analytics research finding that US$115 billion of REIT debt is maturing in 2025 to 2026. 

According to that research, refinancing costs are expected to increase from 4.0% to 5.5%, potentially adding US$2 billion in annual interest expenses for global REITs and impacting office, infrastructure, and healthcare property subsectors most significantly.

In addition to growing interest costs potentially eating into REIT dividends, investors should also remain cognisant of potential macroeconomic headwinds. US-based REITs comprised 78% of the international REIT index at end-December 2024, making the sector highly dependent on the prosperity of the US economy. 

A key concern is that the inflation outlook in the US could force the US Fed to lift interest rates. Wharton Business School estimates that US fiscal policies will expand the budget deficit by an additional US$600 billion annually over the next decade, potentially leading to an overheating US economy. 

Historically, higher interest rates in the US have tended to lower property valuations and increase borrowing costs, which could further delay the long-awaited rebound of international REITs.

Conclusion

Several Exchange Traded Funds (ETFs) on ASX provide exposure to a portfolio of international REITs. [Investors can learn about the features, benefits and risks of ETFs here]. 

Importantly, investors seeking offshore REIT exposures with currency hedging should check with their fund manager if they are managing foreign exchange risks within income-based portfolios, particularly under the Taxation of Financial Arrangements (TOFA) framework and Australia's Managed Investment Trust (AMIT) regime. 

Currency hedging strategies can help investors mitigate the impact of currency fluctuations, potentially providing greater stability to income streams. Income investors should particularly look at the history of a REIT’s dividend income to determine if it is smooth or volatile over the long term.

VanEck always suggests that investors speak to their financial adviser or stock broker before making any financial decision.

-------------------------------

[1] At end-December 2024

[2] source: FactSet as at 17 January 2025.

[3] based on FTSE EPRA Nareit Global REITs index at end-December 2024.

[4] source: Bloomberg as at 16 January 2025)

[5] source: Bloomberg 20 January 2024