The S&P/ASX 200 Index (ASX: XJO) has recovered from the tariff sell-off in the first half of the year, now up 4% in 2025 to date.
A major contributor to the performance has been the 17% rise of Commonwealth Bank of Australia (ASX: CBA) shares this year.
Without a crystal ball, it's difficult to know what's going to happen next. But, there is one sector I'm largely optimistic about: real estate investment trusts (REITs). There are a few different reasons why I think they can help outperform in the medium term.
Defensive earnings
Most REITs have quality tenants that are signed on for multiple years, which means they have largely locked in their rental income and rental profits for the foreseeable future.
When businesses have predictable profits, investors may appreciate that stability.
With much uncertainty surrounding US tariffs, a range of possible outcomes could occur. I think the resilient operating earnings of REITs could be attractive and help the sector outperform the ASX 200 in the medium term.
Pleasingly, the rental income of most REITs is growing organically each year, thanks to increases linked to inflation, or they have fixed annual increases.
Interest rate cuts
The Reserve Bank of Australia (RBA) is seemingly in a period of cutting interest rates. There have already been two interest rate cuts in 2025, and further rate cuts are forecast for the next 12 months.
Interest rate cuts could significantly help REITs in multiple ways. Rate cuts should help reduce the interest cost for indebted businesses. But, lower interest rates could also help push up the value of properties, which could be a significant tailwind for asset-rich businesses like REITs.
I'm not sure how low interest rates will go in 2025, but it seems (at least) two more cuts are quite possible this year.
Valuation discounts to close?
High interest rates have been a headwind for property valuations themselves, but we've also seen REIT unit prices trade at sizeable discounts to their net asset value (NAV).
I think it's quite possible that the REIT sector will see valuation discounts reduce this year amid rate cuts, which could be useful support for capital growth this year and potentially help the sector outperform the ASX 200.
For prospective investors, that large discount means they can receive a larger distribution yield today, unlocking stronger passive income than if the business were trading at its NAV value.
I like the look of some businesses like Rural Funds Group (ASX: RFF), Centuria Industrial REIT (ASX: CIP), Charter Hall Long WALE REIT (ASX: CLW), and a few others.
