AMP Capital finds strong correlation between direct and listed real estate over the long term

Investors seeking exposure to real estate should consider listed as well as direct given the returns, diversification and volatility of the asset classes are very similar over the long term, according to AMP Capital.

Don’t tell me it’s not real estate, a white paper written by AMP Capital Co-Head of Global Listed Real Estate James Maydew, demonstrates the correlation between listed and direct real estate increases significantly as the investment horizon lengthens. The daily liquidity of listed real estate, however, means it behaves more like equities if they only invest in the short term.

Mr Maydew said: “Real estate, both listed and direct, is a long-term investment by the very nature of leases that are contractually committed to and the longevity of the physical assets. The two asset classes are essentially the same over five years and beyond as the returns are driven by the underlying real estate cash flows they have in common. For investors who want to maximise risk adjusted returns, an asset allocation between both listed and direct should be utilised at different points in the cycle. Listed real estate can also be a useful proxy for direct for investors who want to get set in real estate but who are struggling to deploy their capital given global competition for quality assets.”

The paper also highlights how listed real estate can be used by investors as a harbinger of what the direct market is likely to do. Analysis of whether real estate investment trusts (REITs) are trading at a premium or discount to net asset value (NAV) has proven to be an accurate predictor of how the direct market will move in the coming year.

Mr Maydew explained: “Put very simply, if a REIT trades at a premium to its NAV, the market believes its assets will appreciate above levels indicated by market pricing of the underlying direct real estate. If we look at listed real estate in the US since 1988, whenever prices have been at a premium to NAV, direct real estate appreciated 96 per cent of the time in the following 12 months.”

Globally, listed real estate is currently trading at a discount to NAV. The biggest discounts are in Asia, with the US and the UK markets also trading at a discount. Australian REITs are trading at a slight premium, with larger premiums ascribed to Continental Europe and the Japanese REIT market.

Mr Maydew added: “In individual markets where listed real estate is trading at a discount to NAV, the best management teams are taking advantage of strong pricing in direct real estate markets, selling on-core assets and utilising the proceeds to either de-lever balance sheets or shrink their equity base by returning capital to investors.”

Don’t tell me it’s not real estate is the first of a series of AMP Capital whitepapers on listed real estate. Mr Maydew noted: “More global investors are allocating to listed real estate and they are hungry for knowledge and insights about the asset class. We intend to release a number of white papers this year on the sector more broadly as well as a range of diverse individual investment themes such as senior living REITs, shopping malls and the impact of disruptive technology on real estate.”