Real estate is one of the cornerstones of the market that investors are moving into, as expectations of interest rate cuts grow. Markets are betting that this month’s inflation data will give the U.S. Federal Reserve a reason to cut rates, as it has repeatedly said that consumer prices need to fall for that to happen. Real estate-related assets, such as REITs, are generally thought to benefit from lower interest rates. That’s because many investments in this asset class involve leverage and borrowing, and the lower the interest rate, the lower the cost of holding the investment. A low-interest-rate environment also makes this investment more attractive in terms of the higher rental income that real estate provides. But there’s no guarantee — such real estate assets can also perform well when rates are higher. For example, how much borrowing costs depend on debt loads and industry type, among other variables. For those interested in REITs, Morningstar is bullish on the name, which it says is “cheap” and offers a high yield. “Catalysts for future gains” That’s U.S.-listed Kilroy Realty, Morningstar equity analyst Suryansh Sharma said in a July report. The company owns, develops and acquires prime office, mixed-use and technology and life sciences properties in U.S. cities. Also in July, Dave Sekera, Morningstar’s chief U.S. market strategist, named Kilroy among four new stocks to buy “with catalysts for future gains.” “The fund has positioned itself to benefit from the booming life sciences sector with physical exposure in its portfolio and development pipeline,” Sharma said, adding, “We believe that while remote and hybrid work solutions will gain increasing acceptance, offices will remain central to the workplace strategy.” He gives Morningstar a fair value estimate of $59 per share, which means it is 46% undervalued, he said. Office utilization is set to increase over time, which in turn will lead to a recovery in demand for office properties, he said. Over the next decade, Sharma expects a 0.9% CAGR in average rent per square foot for Kilroy’s portfolio. “We believe Kilroy’s large development pipeline will deliver yields of approximately 6.50% through 2033, adding additional net operating income and contributing significantly to the company’s valuation,” he said. Kilroy’s dividend yield is currently around 6%, according to FactSet data. “The focus on the technology and life sciences market groups should benefit Kilroy over the long term as we expect strong growth in these areas,” Sharma said. “The company’s high-quality office buildings with good amenities should benefit from the shift to quality.” Sequeira noted that Kilroy is “one of the most undervalued REITs” under Morningstar’s coverage, but one positive is that the company is biased toward the technology sector. “When we look at hiring in the technology sector, it’s growing,” he said. “When we look at the tech job metrics within specific market areas, some of the biggest tech companies like Apple, Alphabet, Amazon, and Meta are all asking employees to return to the office, and to return to a hybrid work schedule at least three days a week,” he said. He also noted that the buildings in Kilroy’s life sciences portfolio are only 11 years old — much younger than many of their peers. That should lead to better occupancy rates, Sequeira said. But investors should note that overall, the ongoing remote work dynamic across industries will continue to pose a significant risk, according to Sharma. “The remote work dynamic is probably the biggest source of uncertainty in the office real estate industry. The pandemic has shown us that technology can help employees collaborate and stay productive while working remotely,” he said. “Hybrid workplace policies are now increasingly the norm and pose a significant challenge to future office demand.”
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Buy this 'cheap' real estate fund set to deliver nearly 7% return, according to Morningstar
