Investors looking to invest in data centre REITs need to do their homework and due diligence.

The AI boom has reshaped the data centre landscape at a pace few anticipated. The sector is evolving rapidly, driven by the growth in spending by large US ‘hyperscalers’ such as Amazon, Alphabet and Microsoft. These companies are pouring billions of dollars into AI and expanding cloud capacity, providing tremendous opportunities for REIT investors, says Quay Global Investors assistant portfolio manager, Gavin Truong.

But Mr Truong said not all data centre REITs are created equal, and investors need to understand what to look out for when investing in this sector.

“The US hyperscalers’ budgets for AI and cloud capex have increased almost every time they report quarterly earnings. Notably, these increased capex budgets came despite the release of DeepSeek in January 2025,” he said.

“It is expected they will only keep spending. This investment has been rewarded by the market and share price growth has been incredible, providing the backbone to equity market gains over the past year.”

Projections for additional data centre capacity needed between 2025 and 2030 vary greatly – from around 69 GW to 188GW – but with global capacity at 81GW at the end of 2024, the consensus is for capacity to more than double.

Mr Truong said demand might be insatiable, but the supply of centres could be limited by a shortage of power, which is more of a problem in established data centre markets. This is driving new builds into secondary and tertiary markets, where land and power are relatively easier to secure.

He pointed to RBC estimates that roughly 132GW of potential projects are planned globally in the next 10 years if all landbanks are utilised.

“However, under construction figures are much lower with over 12GW of data centre capacity under construction in North America as at August 2025, up 33 per cent from 9GW in May 2024. Globally there is over 23GW under construction, which is over 25 per cent of total existing stock.

“Given the very high demand, much of those data centres under construction in primary markets are pre-leased – nearly three quarters in the US alone. In North Virginia, 87 per cent of the 2GW under construction is already pre-leased.

“With a typical data centre development taking three years to build (up from two), and mostly pre-leased before delivery, existing data centre capacity in established US markets is in high demand,” Truong added.

“Vacancies in these established markets continue to set new record lows, most recently falling to 1.6 per cent as at June-2025. This is despite an almost triple increase in supply this half (MW) compared to four years ago

“In 2025 market rents for hyperscale leases over 10MW have grown by 13.8 per cent in North Virginia,19 per cent in Silicon Valley and 15.4 per cent in Chicago. This is beneficial for data centre owners that can deliver capacity in these top US markets.”

While data centre REITs obviously remain popular due to these many factors, for an investor it is important to consider which REITs are most likely to thrive, he said.

“We believe those that have a global data centre platform, have meaningful exposure to hyperscale-type data centres, particularly in the US, and are able to develop new data centres, are the most likely to outperform.”

A careful consideration of valuation is also required.

“Some data centres, but not all, have earnings growth that has kept up with share price growth, keeping valuation multiples attractive. The larger companies with diversified global platforms, notably Digital Realty and Equinix, have outperformed. Digital Realty has one of the lowest valuations among its global peers of 19.4 times as at 19 September 2025 and Equinox’s valuation was only slightly higher at 19.7 times.

“In contrast, Australian-listed data centre REITs continue to trade at significant, and in our view, unjustified premiums. DigiCo had a one-year forward valuation multiple of 26.5 times in mid-September and Next DC’s valuation was a whopping 51.6 times,” Truong said.

Investors looking to invest in data centre REITs therefore need to do their homework and due diligence.

“A high share price is not enough, and nor is assuming that all data centre REITs will continue to outperform as demand across the sector grows.

“Investors still need to look carefully at the structure of a REIT, with data centre scale and geographic reach remaining differentiators, and exposure to the US hyperscale market a clear advantage.

“As always, valuation discipline is critical — investors should balance the sector’s compelling growth prospects against current pricing to identify the most attractive opportunities,” Truong said.

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If we were to rewind back to the years leading up to the global financial crisis (GFC) of 2007/08, some key economic factors stand out. House prices were on a sustained upward trajectory, growing +42 per cent1 between 2003 and 2005. Annualised US inflation rose from a low of ~1 per cent in June 2002 to over 4 per cent by September 2005. The US Federal Reserve (Fed), in response to this high inflation, increased the effective federal funds rate from 1 per cent to 5.25 per cent between June 2004 and July 2006. By 2008, mortgage delinquencies spiked, US house prices crashed, and the financial shockwaves paralysed businesses and economies across the world.

Fast forward to the present day, when we live in a financial environment seemingly facing many of these same trends. House price growth post pandemic has been historic in both magnitude and speed. Inflation is high and appears stubborn. The Fed is expected to continue to lift interest rates aggressively. For many investors this is like Groundhog Day of the GFC. Fear, particularly around US house prices, is circulating widely.

In this article, we seek to dig deeper into the detail, and try to understand the implication for US housing. 

First, a refresher on the GFC

The main driver of the GFC was the US subprime mortgage crisis, which in turn became a household balance sheet crisis (too much debt against falling asset values). In the US, house prices grew strongly for years in a regulatory-light environment where mortgages were handed out to almost anyone who wanted one – including borrowers with bad credit scores and/or no income, no job, no assets (‘NINJA’ loans) – with no down payment necessary.

In many respects, it was peak euphoria; sustained house price growth drove increased demand for mortgage finance as speculation and fear of missing out increased. Financial markets met this demand by aggressively handing out new loans, and subprime loans were securitised into bonds which became an in- demand investment product. Loose lending practices meant more money flowing into the housing sector, driving up house prices. It seemed like an ever-upward spiral. Crucially, supply of new housing (construction) also spiralled as development margins swelled.

In mid-2004, the Fed began their interest rate hiking cycle. This not only curtailed the quantum of new lending, but also increased repayments for borrowers on variable rate mortgages. In many instances, borrowers did not have the cashflow capacity to meet the higher repayments. In fact, many borrowers did not set out with a plan of repaying their loans over the long term, instead banking on flipping their property for a profit in a few years’ time. Of course, when the Fed rate ballooned from 1 per cent to 5 per cent, and their properties entered negative equity, many of these loans became delinquent.

House prices cratered as sentiment soured. Houses for sale increased and speculators disappeared. This not only affected lenders, but also tore up the US subprime mortgage bond market and the institutions heavily invested in these bonds. Shockwaves were felt all over the world across stocks, bonds, derivatives, and the credit market.

What’s changed?

In 2010, the Dodd-Frank Wall Street Reform Act was enacted to promote the financial stability of the US, with an array of regulations imposed on financial institutions. One of the outcomes of the Act was the creation of the Consumer Financial Protection Bureau (CFPB), which aims to regulate mortgage lending standards and protect against predatory lending.

The change in the regulatory environment has meant the disappearance of NINJA and other high risk mortgage loans, a better-informed borrower and less risky lending for housing.

Source: New York Federal Reserve

The above chart shows the average Equifax credit score of mortgage borrowers originated by year. Prior to the GFC, the 10th percentile of mortgages was underwritten to borrowers with a credit rating score barely above ‘poor’ (<579). In the years since, there has been a marked improvement; most noteworthy, the increase in the median credit score to high 700s (‘very good’) and the 10th percentile of loans to borrowers with a score in the high 600s (‘good’).

In our view, this dramatically decreases the risk of a 2008-style event happening this time around.

Source: US Federal Reserve

We can see this trend in the single-family mortgage delinquency data, with the most recent data from April 2022 showing the delinquency rate has fallen below 2 per cent to multi-decade lows. In fact, the last time it was sub-2 per cent was in 2006. However, 2006 also tells us this number can shoot up quickly. By 2009, the delinquency rate was over 10 per cent.

In our view though, a number of factors mitigate the risk of delinquency increasing both at the speed and magnitude of the GFC.

First, what we have seen since the GFC is a significant drop in the proportion of adjustable rate mortgages (ARM). Prior to the crisis, up to a third of mortgages written were effectively on a variable rate (or very short fixed term). At the time, these variable rate loans were also highly correlated with being a subprime borrower. Post GFC, ARM has been below 10 per cent. Importantly, regulatory changes have meant that ARMs underwritten post-GFC have more stringent standards too.

Source: US Mortgage Brokers Association

The outcome of the fall in the proportion of ARM loans has meant that the transmission mechanisms of interest rate rises by the Fed has far less of an impact on US housing than in the past. In the last decade, over 90 per cent of new loans have been underwritten on a fixed rate mortgage of 15 or 30 years. These homeowners would also be sitting on significant equity. According to research by Black Knight, as at the second quarter of 2022 only 0.4 per cent of homes are in negative equity. Even with a 15 per cent price decline, this number would only forecast to increase to 3.7 per cent – and almost the whole 3.7 per cent would be made up of purchases in late 2021 and 2022. In 2008-09, the negative equity rate was over 20 per cent^[2].

Secondly, after the record levels of pandemic stimulus, US household balance sheets are stronger than ever. As discussed in last month’s Investment Perspectives article, Why interest rates aren’t working yet^[3], US household net financial debt is back to 1996 levels. The household balance sheet recession that enabled the GFC in 2007-08 is high unlikely to occur again in the current environment.

Source: St Louis Fred, US Federal Reserve, Quay Global Investors

Implications for housing

In our view, after weighing up the evidence, the possibility of a GFC style housing crash is unlikely. The housing market is in much stronger shape due to stricter regulation and lending practices. Delinquencies are near record lows and unlikely to spike. Household balance sheets are strong, the overwhelming majority of owners are in positive equity territory, and ~95 per cent of all loans are fixed for 15-20 years.

Of course, in the short term, house prices could somewhat correct. House prices, like any other asset price, can be impacted in the short term by the cycle of market emotions. ‘Fear of missing out’ or the ‘fear of not getting out’ can swing prices one way or the other. In the long term, however, house prices will be driven by replacement cost, which for single family housing, continues to increase.

Source: American Homes 4 Rent

Another angle not spoken about enough, in our view, is the strength in rent. While a NAV investor may get jittery at the thought of downside risk to housing prices, for a cashflow-based investor high rental growth – and in particular the durability of high rent – is exciting news. We can discern whether rental growth is durable by examining the gap between the demand and supply of housing.

Source: National Association of Home Builders

We believe US single family housing is chronically undersupplied, with housing starts post-GFC not sufficient to meet growth – both for overall population and the proportion of family-forming millennials. Starts data in recent months have also fallen dramatically, adding to the future gap. Homebuilder sentiment has soured, with the NAHB housing market index falling to 46 in September 2022 (a rating under 50 is considered low).

Rent, unlike house prices, is in our opinion a more accurate reflection of the underlying demand for housing against available supply, as the element of emotion is absent.

Source: American Homes 4 Rent

The above chart shows rental growth on leases signed for one of the largest single family housing landlords in the US. What we see is clear evidence that housing demand is greater than available supply. With interest rates rising, building confidence low and new starts falling off, the gap will only grow larger. This bodes well for future rent and housing landlords prospects going forward.

Rent in US single family housing (highlighted in orange in the chart below) is also on the affordable end of the market compared to US apartments. This factor, combined with the undersupply dynamic, will add to the resiliency of the sector.

Source: Company reports

Finally, it’s pertinent to note that US housing rent has been remarkably resilient, even in downturns. Digging into historical US Consumer Price Index (CPI) data, we have calculated the per cent change year on year of rent of primary residence in US cities. Since the turn of the century, rent measured by the US Bureau of Labour Statistics’ survey has only fallen three times year on year – in May, June and August 2010 (circled in red in the chart below). In these cases, the fall has effectively been near 0 per cent. In fact, rent was still growing in 2007 to 2009 (during the height of the GFC). Given the uncertainty in the economic outlook, this only adds to the attractiveness of the sector.

Source: US Bureau of Labour Statistics, Quay

Implications for housing

As is always the case, market volatility can create anxiety due to daily (negative) mark-to-market events. However, the same volatility can present investors with outstanding long-term investment opportunities.

Housing is largely non-discretionary and is critical infrastructure in any modern economy. While recency bias from the GFC may cause fear, the negative impact on housing is not supported by the data in the current climate, especially for single family homes. In particular:

• Household balance sheets are in their best shape since the early 1990s
• 95 per cent of all mortgages are fixed
• Credit standards have improved significantly
• Housing is undersupplied based on the collapse on new starts / deliveries since the GFC
• Threats of future oversupply are being eliminated by central bank actions, and rising replacement cost is ensuring the ‘breakeven price’ for new construction is
• significantly higher than current market prices, and
• Even during the worst housing crisis in a century and clear evidence of oversupply, rent and cashflows continued to grow during the GFC for single family homes.

At Quay, we have high conviction in the US single family sector based on these observations. We continue to maintain a meaningful exposure to the sector and expect these investments to comfortably exceed our long-term investment objectives.

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Sources:
[1] S&P/Case-Shiller U.S. National Home Price Index
[2] Black Knight Real Estate, Inc.
[3] https://www.quaygi.com/insights/articles/investment-perspectives-why-rising-interest-rates-arent-working-yet?mkt_tok=NjgwLVBISC02ODEAAAGGkUGmtjlOSkPATVEz4nvpe6Svbgy0yRD787xi3wL7gj6cdTGH9m-Wbcko38RMVLRAmJeWh5LYIjAsIQwpAYc 

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What it means

At a time when many commentators are grappling to find an analogy to explain the current inflation episode, we believe it’s worth considering what happened in the United States in 1947.

At the time, the US was beginning to recover from global disruption caused by WWII. Global productive capacity, which had previously been focused on (or destroyed by) the war, struggled to supply post-war consumer demand as soldiers returned home from Europe and the Pacific. Additionally, wartime price controls were removed. Two years later, the US CPI was +14.4%. By 1949, the change in CPI fell to a -1.0%.

Was this decrease driven by a large rate hike cycle enacted by a hawkish Federal Reserve?

No. In fact, the Fed’s 12-month rate increased only slightly from 0.75% in July 1947 to 1.25% in Aug 1948. The real driver was the natural expansion and recovery of US / global productive capacity after a traumatic disruption to normal operations.

Looking back, the 1947 inflation was clearly transitory (despite the two-year lag in CPI data). It begs the question: will we come to the same conclusion with the current inflation episode?

What it means

In a post-COVID world, surging demand for housing after a decade of undersupply has driven strong house price growth in the last few years. Consequently, supply has responded, with houses under construction booming since June 2020.

However, the current level of new supply is dwarfed by the decade long cumulative undersupply, as shown in the shaded area of the above chart. This is currently providing landlords with excellent pricing power and rent growth.

What it means

The core reason real estate is seen as a long-term hedge against inflation is the increase in replacement costs, which makes building new supply at old prices difficult to justify.

The current inflation episode is feeding through to rising replacement values for most forms of real estate, including residential property. With tenant demand surging as economies have re-opened, it’s likely supply will be unable to fully respond in a timely manner due to rising costs (see previous chart). And while landlord pricing power is very strong today, the increasing cost of supply will almost certainly constrain medium-term supply and underpin future capital values.

What it means

Market headlines about the increase of housing inventory for sale have revived fears of another GFC-style housing crisis in the US. In our opinion, the above chart shows that this fear appears somewhat overblown.

The chart compares monthly housing inventory for sale this year against the same months in 2021, 2020 and 2019. Yes, housing inventory for sale has increased to above 2021 levels, but it’s still -34% off June 20 levels and -53% of pre-COVID June 19 levels.

Current inventory levels do not appear excessive.

What it means

Historical monthly changes in US house prices (Case-Schiller Index, measured on the x-axis) can be largely explained by months of housing inventory for sale (total existing houses for sale divided by average houses sold per month, measured on the y-axis) as depicted in the chart above.

The most recent (June 22) data is currently tracking at 3.0 months inventory supply, which has correlated with 1-2% monthly price increases. Of course, the driver of house prices is much more nuanced than this. However, it’s interesting to note that historically, month-on-month prices have not fallen until monthly housing inventory is above the 6.0 months mark – roughly double where we are today.

What it means

Rising interest rates, a slowing economy, talk of recession – these macro stories are enough for investors to avoid anything related to discretionary retail. However, the post-COVID rebound in retail and household consumption has been so great that even a 3% real contraction in sales results in actual volume of sales well above pre-pandemic trends.

The lesson? Rate of change is important, but so too is absolute levels. And even under a scenario of a 3% decline in retail sales volume (represented by the orange line), retailers are still doing well.

What it means

In-store retail sales have gone from strength-to-strength post-pandemic, despite market predictions about the COVID-accelerated death of brick and mortar retail. Will a recession change the story?

Maybe not.

As with total retail sales, even after allowing for a real 3% decline in sales volume, retail landlords are generating the type of sales volume unimaginable in pre-COVID 2019.

What it means

Part of the bricks and mortar story can be explained by what’s happening in e-commerce. In a recent letter to employees, Shopify admitted that its expectation for on-line post pandemic growth was disastrously wrong^[1], echoing Amazon’s recent comments.

Part of this could be explained by mean reversion consumer behaviour. However, the data for this chart indicates there could be more to the story. The cost of doing business for online retailers is rising rapidly, as privacy concerns (via online tracking) and search costs rise.

As online costs rise, retailers may be forced to re-think their physical store strategy and halt – or even reverse – store closures, potentially ending the decade-long loss of market share by shopping centre landlords.

What it means

It has been a torrid 2022 for tech-related stocks. Hiring freezes or reductions in leading companies, such as Meta, Netflix and Google (Alphabet), have raised concerns of a tech wreck similar to 2001. A knock-on effect is the concern that there will be a new scarcity of venture capital (VC) funding, impacting key industries and related employment.

This is important for real estate due to the real and perceived exposure some sectors have to the tech heavy industries and markets (for example, US West Coast residential and life sciences).

However, the chart above shows investors continue to allocate to VC funds despite the negative headlines. VC funds raised in 2022 (to June) are well on track to break the 2021 record of $139bn. There are no signs of slowdown yet.

What it means

VC deal volumes closed so far this year are much higher than pre-pandemic levels. Given the record fundraising levels shown in the previous chart, this suggests there is a lot of cash in sitting on the sideline. If equity markets stabilise, or turn around from here, VC deals could come back strong.

On a sector level, pharmaceutical and biotech volumes are on track to receive more VC money in 2022 ($20bn) than 2019 ($12bn). This bodes well for our investee, Alexandria Real Estate (ARE US), a life science landlord, which has been sold off -35% YTD based on market concerns about VC funding levels.

What it means

Office attendance in the major job markets in the US and Australia have been increasing, but is still only 30-40% of pre-pandemic levels in the US and roughly 50% in Sydney and Melbourne. Leased office space, however, has not fallen to the same degree (yet). We believe this is due to the fact employers need to factor in scenarios for days where most employees attend the office despite a standing WFH policy. We discussed this in more detail in our article, Thinking about office^[2].

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[1] https://www.businessinsider.com/shopify-layoffs-10-percent-ceo-memo-2022-7
[2] https://www.quaygi.com/insights/articles/investment-perspectives-thinking-about-office

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Chris Bedingfield

With equity markets approaching all time highs, and fixed income markets still sitting near all time lows, the prospect of higher interest rates has been unsettling markets. But investment opportunities exist in all market cycles says Chris Bedingfield, principal and portfolio manager of Quay Global Investors.

“Interest rates around the world have been very low for some time and now there is the real prospect that the US, in particular, is thinking of increasing interest rates.

“Conventional wisdom has it that when interest rates increase real estate does poorly, and vice versa. Indeed, real estate is often considered a bond proxy. But the data doesn’t necessarily back this up and rising interest rates are not always the enemy of real estate.

“We have long argued that real estate valuation is far more nuanced than a simple net present value of static cash flows.

“People tend to forget that real estate is a growth asset as well. If interest rates are increasing because the economic outlook is improving, that may be a net positive for real estate.”

Mr Bedingfield points to the past interest rate rising cycle in the US – between 2004 and 2007 – where rates went from around 1 per cent to almost 4.5 per cent.

“Over that period, US real estate companies put in a total return of over 60 per cent – almost double that of US equity markets during the same period.

“For real estate investors, rising or falling rates is not necessarily positive or negative because the key to successful real estate investing is to understand the demand and supply equation.

“We look for investment opportunities where there is a demand / supply imbalance; and where underlying demand for space is greater than overall supply. That is usually a positive for real estate as landlords can increase rents and grow their cash flows, regardless of other economic considerations.”

However, the prospect of rising interest rates does influence the types of property investments that should be undertaken, Mr Bedingfield says.

“In some areas of the real estate market, there is a risk they will be overly exposed to the rising rates environment. Examples of that are real estate companies with exposures to very long leases, very certain cash flows, and contracted rents.

“Healthcare is a good example of that. Healthcare property doesn’t really benefit from improved economic activity associated with rising interest rate cycles. If the US economy improves, for example, this doesn’t have a correlation to more people getting sick or old. For this reason, healthcare is one area that tends to be more exposed in a rising rates environment.

“On the other side of the equation, office and retail, plus rental apartments do tend to do quite well in a rising interest rates environment if it correlates with job and wages growth.”

On the whole, Mr Bedingfield is optimistic about the prospects in global real estate markets.

“Yes, rental growth will moderate, but we still believe a well-constructed portfolio of quality global listed real estate securities will generate our targeted total returns – of CPI plus 5 per cent – over the medium and long term.

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The shock of Brexit appears to be the catalyst for the recent capitulation, although we believe the reasons for sustained low interest rates are more structural.

Monetary economics is failing

In February’s article “Are central banks losing their effectiveness“, several reasons were highlighted as to why low interest rates and Quantitative Easing will not work in addressing economic stagnation, namely:

• low interest rates generally work by encouraging private sector credit creation. Unless the private sector is willing to borrow, low rates will not stimulate growth. With private debt at or near record highs worldwide, sustained growth in credit is unlikely;
• as the Government is a net payer of interest, the non-government sector naturally is a net receiver of interest income. Low interest rates reduce net income to the private sector – effectively acting as an additional tax on savings; and
• quantitative easing involves the Central Bank acquiring high quality high-yielding financial securities for low-yielding cash. Again, this diverts net interest income from the private sector to the Government.

Central banks don’t yet see their actions (low interest rates) as deflationary. Unless there is a complete change in mind-set (like acknowledging that sovereign credit ratings do not matter), low rates are here to stay. In other words, insofar as lower interest rates stoke inflation, let the beatings continue until morale improves!

Investment implications

As a global listed real estate manager, one would think ‘lower for longer’ is positive for the asset class. Furthermore, low interest rates should be good for other yield-based investments as investors hunt for income. However, low interest rates are not always good for real estate – much in the same way rising interest rates are not always bad.

The main problem with permanently low interest rates are the distortions it can create in the real economy over time. These distortions can take many years to ‘play out’ – but are worth considering today for long-term investors. The areas of distortion include:

• structural declines in company return on capital, feeding back to lower shareholder returns;
• falling net interest margin in the Banking sector; and
• potential to accelerate a supply response in real estate.

We discuss these distortions in greater detail below.

Low interest rates alter real investment decision making process

The poster child for sustained low interest rates is Japan. The Japanese economy is in no way disastrous. Unemployment has been quite low and real GDP growth per worker is actually better than most western economies post GFC (Japan +12% versus Europe flat). Yet inflation has remained stubbornly low. Much of this, we believe, is due to a structural decline in Japanese return on capital, which was driven by low ‘hurdle rates’. The ever-lower return per unit of capital has created an extremely low inflationary environment.

The lesson: as investors chase yield, they may make the mistake of assuming profits are sustainable. Yet in a low interest rate environment, the acceptance of lower returns on capital will feed itself back to shareholder returns, which is bad for stock prices. As we write today, the Nikkei 225 is around 57% below its 1989 peak after almost 20 years of zero interest rate policy.

Distortions in Banks

In Australia, one of the more favoured investment choices in a falling interest rate environment has been the Banks. Industry concentration and strong pricing power has ensured healthy margins – irrespective of the headline interest rate. Very high return on equity supported high dividend yields and growth.

But as Australian interest rates head lower, the risk is bank margins will contract. The net interest margin (the difference between the average funding / deposit rate and lending rate) will be very hard to sustain. Banks will be unwilling to price deposits at zero or less. Add some additional competition for lending as private sector appetite for new loans diminish, and margins begin to shrink.

This is more than just theory. A recent paper entitled ‘”Low-for-long” interest rates and net interest margins of banks in Advanced Foreign Economies’ (Claessens, S., Coleman, N. & Donnelly, M., 2016) noted that banks residing in a ‘low interest rate environment’ (three month bond yield < 1.25%) earned progressively lower net interest margins as interest rates declined. The risk is that Australian investors chasing a high-yielding bank today may have a very poor earnings outlook in a near-zero interest rate environment. Include the risk of rising bad loans (see below) and the ‘Bank’ story is far from compelling.

Distortion in real estate

The distortions caused by low interest rates in Real Estate are no less pronounced.

As investors chase yield in Real Estate, ever higher asset values (measured by implied and actual cap rates) bid up the underlying bricks and mortar. While short-term investors feel they are getting a better ‘yield deal’ compared to cash, what they may really be doing is acquiring the underlying property at a premium to replacement cost. This in turn encourages a supply response as the following chart demonstrates.

The risk to the Real Estate sector is more pronounced at the ‘commodity’ end of the real estate spectrum – such as Office, Industrial, and select Residential property.

The chart below highlights the issue for US Industrial REITs. They’re currently ’flavour of the month’ due to their e-commerce exposure, strong ’same store rent growth’ and yield, but investors have pushed enterprise values for many listed entities to a point that encourages new supply. Supply that is likely to be on-going until share prices reflect a discount to new stock.

In Australia, since 2012 the RBA has progressively lowered the official cash rate (now 1.5%), which in turn has caused a significant increase in local property prices (especially residential). House and unit prices are now well above replacement cost resulting in a very significant supply response – especially in Sydney.

For investors who believe low interest rates will keep residential property prices elevated, we have to respectfully disagree.

We find the following chart a concern. Investors in Australian Banks should share this concern. Why? Because Banks effectively write Put Options against residential property, leading to leveraged exposure to a decline in property prices.

Implications of the ‘chase for yield’

We believe sustained low interest rates and the ‘chase for yield’ will actually work against most investors over the long term. Not just in real estate – but across the economy, with particular concern for Financials and Banks.

Despite our concerns, we believe there are very attractive long-term global real estate opportunities in a low interest rate world. Real Estate that is hard to replicate (flagship malls, well located residential and retirement property as an example) will continue to do well. Even at the commodity end of the real estate spectrum there are assets still priced below replacement cost – albeit these opportunities are becoming rare.

Interest rates will be lower for longer. The key to investment success will not be allocating to yield – but by getting stock selection right.

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Disclaimer: The content contained in this article represents the opinions of the authors. The authors may hold either long or short positions in securities of various companies discussed in the article. The commentary in this article in no way constitutes a solicitation of business or investment advice. It is intended solely as an avenue for the authors to express their personal views on investing and for the entertainment of the reader. In particular this newsletter is not directed for investment purposes at US persons.

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Chris Bedingfield

The use of low interest rates by central banks to help assist recovery is unlikely to have the desired effect, and may ultimately cause significant market disruption, says Chris Bedingfield, principal and portfolio manager at Quay Global Investors.

“Much of the share market recovery since 2009 has been attributed to ‘easy money’ – including the policy of quantitative easing,” he says in his latest Investment Perspectives paper.

“While the real economic benefits from central bank policy are questionable – and the US economic recovery has been muted at best – it seems they have not finished with their aggressive approach.

“The question is, will it work? We think not.”

Chris says low interest rates by themselves have very little impact.

“The main stimulus from low interest rates is an increase in demand for loans, which are then used to acquire assets or goods and services. It is the newly created money that is the stimulus.

“At very high levels of private debt, however, these lower interest rates begin to lose their effectiveness.

“If banks are unable to source significant credit worthy customers, or the private sector is unwilling to borrow, then the level of interest rates becomes irrelevant. New credit will not form, and monetary policy loses its effectiveness.

“More importantly, negative interest rates become a cost for the banks (or their customers if negative deposits rates are passed on). This reduces net income from the private sector in the same way as introducing a new tax. Negative interest rates are, at the margin, deflationary.

“Reducing interest rates below zero to stimulate inflation is akin to a hairdresser complaining ‘No matter how much I cut it, it’s still too short’!”

Chris says the long-term impact of the quantitative easing approach is still to be seen, and that it could have significant consequences.

“For example, there has been something of a cottage industry since the last financial crisis, predicting the next ‘black swan event’. Most are based on forecasting another debt crisis.

“However, we believe it is unlikely that a 2008 style debt crisis will re-emerge so quickly. In the companies that we cover, we’re seeing that leverage has reduced, pay-out ratios have declined and companies are keeping high levels of liquidity available.

“It seems to us that the next shock is likely to arrive from a surprising source, and one of these sources could well be the loss of confidence in central banks. Central banks are running out of ammunition, outside of the placebo effect of being seen to do something. But the positive effects of a placebo do not last forever.

“It is really only a matter of time before markets accept the true limitations for monetary policy. When this occurs, the loss of confidence of the Bernanke/Yellen/Draghi ‘put’ option could cause significant market disruption,” Chris says.

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