When do we go back to property (REITs) and private equity (PE)? We look closely at these two areas, as there appears to be nothing new to see or say on interest rates or inflation.

Macro is dull just now

Neither the Fed nor the Bank of England, nor indeed the ECB meet this month. So, the default is to assume a half point rise all round. Which should mean Western central banks are broadly aligned for a while, so by implication are currencies.

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Recessions lag rate rises, so are not due yet either, although clearly one is coming.

Inflation will probably drift lower, but the employment markets stay strong, as the shuddering readjustment out of COVID continues to keep churn elevated. In person service hires roughly balance stay-at-home sector losses for now.

Basic food commodities, which have driven much of the recent inflation surge, will stay elevated until the current crops/stock are harvested and replanted late in the spring. Energy is possibly oversupplied for this winter. So not that much change in those two inflation drivers yet. 


So, when is it safe to go back into risky assets? We look at two contrasting stories, firstly REITS which are seen as bond proxies, so cannot properly bounce until rates top out. This seems to need a couple of months at “no change” from the Central Banks. We are less sure about quantitative tightening ending, but most of the market gets spooked by that too. We think it matters little, because masses of global liquidity make what US banks hold somewhat irrelevant.

Nor do we see why REIT assets held on 7–8-year leases with typical debt fixed for half that term, should oscillate so violently over a few months, but that’s life, they just do.

Does property matter?

Institutional interest is not high, we know that, and most institutions need daily liquidity before all else, which lumpy property can’t give. Plus, for boring old REITS a lot has changed for the worse.

Who knows where retail space settles? It remains over supplied (and overtaxed), likewise probably office space, with the added wrinkle of retrofitting for carbon neutrality. COVID created an excess of new storage and warehousing, which also needs to be worked through, so that’s not safe either. While no institution wants the grief (or bad publicity) of dealing with individual tenants and homeowners, so we have long thought if you want to play the residential market, buy high street banks, as a  kind of proxy. Mortgage lending is about all they do now.

It is private investors who still love property as a tangible asset; most are over invested in property and have been over rewarded for being so. Habit really. But if they had that habit before, they are still keen to know when to step back in, at bargain basement prices.

Private equity

Now PE, is a bit different. Yes, private investors like it (like hedge funds) but trust it about as much. Never sure why you would buy a car with just an accelerator pedal, and only forward gear, but most investors buy just that: no shorting, long only for ever. Must be nice to have a mind wedded to constantly rising prices (which long only implies).

PE is just that, so you are buying for management endlessly improving, but adding into the mix a belief in high gearing. You also believe that the managers will constantly be selling and buying investments at a profit. So, you must endlessly mark up your stock, to shift it too.

Can it really work like that?

Markets do not agree.

So, while there are many eye-wateringly deep discounts in PE, markets expect debt to blow a few things up and prices to sell stock to be cut back hard. With some reason, big banks have a shed-load of deal related debt stuck on their balance sheets, probably a fair bit of equity too, and no one is underwriting an IPO, if there is a scintilla of risk left involved. So, unless it is marked down, we have a stand-off, a buyers’ strike.

And in tech, the flaky stuff (AIM etc) is back down below pre-COVID levels, and possibly still falling, which is logical. The better stuff, but with an FX impact, bottomed out a while back, possibly in June? The big “portfolio” quoted holders did so in October, when discounts maxed out around 50% and the FX (i.e., dollar) tailwind was keeping asset values rising.

NASDAQ – a proxy for private equity

However, the NASDAQ hit a new low on 28th December, and that looks much less like a clear bottom, more a long base from October. It is a tough call; NASDAQ multiples drive PE valuations, so that is not helping. Investments with three year’s money a year ago, now have two year’s cash and judging by the speed of layoffs, know that when that drops to one year, funding lines either dry up, or get super pricey. And I don’t see FX helping much this year.

So yes, massive discounts, but also yes, huge lags and the normal discount implied for firms that mark their own homework  on the valuation side.  Audit firms may also be growing more supine (or getting sacked if they ask the real questions).

So, on a five-year view the sector is fine, even cheap, but on a five month or five-day view?  The jury is still out.

While the PE sector is still looking better than REITS in terms of recent prices, it is still, in our view, the one that has yet to base out. If the reason for revival is a flourishing IPO market, that feels more like three years away; by contrast the stability in interest rates that REITs need will probably arrive this year.

So, we stay in touch with both areas, but by no means all in – not just yet anyway. But nor given the performance and yield they give, can they be ignored for ever.      

Welcome to 2023.

Charles Gillams