Reviewing the returns of the various property types in the Index subsequent to the election, it is clear that the duration of the lease term was the most important factor in determining the relative winners and loser. However, there is a ceiling to the reflation trade for even the most ardent fan of Donald Trump and a unified Republican Congress; otherwise, active REIT managers can just shorten the duration of their portfolios and outperform for 2017 and beyond. A number of mitigating factors come to mind: “monetary offset,” global yield differentials and the real possibility that Trumpflation may disappoint in actuality.
It is interesting to note that for the Staff of the FOMC, the risk to their projections for real GDP growth (which they characterize as “similar to the 20-year average”) is actually to the downside since “monetary policy appears to be better positioned to offset large positive shocks than substantial adverse one.” The Staff seems to be espousing the concept of monetary offset, defined in a recent Bloomberg article as “an effort by a central bank, which guides monetary policy, to use an increase in interest rates to tamp down economic growth spurred by spend or tax cuts, the fiscal policy of its government.” If the FOMC’s mandate is “maximum employment, stable prices, and moderate long-term rates (Federal Reserve Act of 1977),” and if its members believe that we are already at full employment, then don’t they have to sterilize the excesses of future fiscal stimulus? Moreover, with yields on sovereign bonds of comparable credit quality hovering near zero, how much higher can the US 10-Year Treasury Note yield go given global capital flows?
Finally, what are the chances that a first-time president (with significant personal volatility) working with a unified Republican Congress (that may not be laboring under same mandate as the President), can deliver all the tax reform, deregulation and fiscal stimulus that an 8.8% move in the Russell 2000 Index implies? After all, Ladbrokes, the British-based gambling company, is offering 11 to 10 odds that Donald Trump will “leave via impeachment or resignation in the first term.” As with the Affordable Care Act, it may be easier to tear something down than to build something up.
At the end of the day, there are limits to hopium and there will eventually be demand for the durable cash flow characteristics of commercial real estate as represented by REITs, even those with long-duration leases; relative performance in the long run will be determined by fundamentals and the laws of supply and demand. However, the valuation band between REITs trading at discounts and premiums to Net Asset Values have been stretched recently beyond historical norms by the influx of passive money and generalist investors (who seem to be more thematic in nature than dedicated REIT investors) so… to quote Jean-Jacques Rousseau, “patience is bitter but its fruit is sweet.”