James Maydew
Deputy Head of Listed Real Estate

The outlook for listed real estate

Listed real estate was the most popular equity sector for institutional investors in the first quarter. This insight article reveals why.

The most popular equity sector for institutional investors in the first quarter of this year was listed real estate. The latest AMP Capital Institutional Investor Report, compiled by Institutional Investor magazine, found almost a quarter (24%) of respondents increased their allocation to this asset class.

There are several reasons why listed real estate was the most popular equity investment

One is that as investors around the globe return to, or increase their investments in equities, they are seeking sectors that offer the benefits of the rise in equities but without the volatility that has been associated with them over the past few years.

Real assets real returns

Investors seek equities that offer consistent yield, are less volatile, yet still have opportunities for capital growth.

Real estate is one such sector. It invests in companies that invest in real assets - real buildings, shops, offices, warehouses, apartments and houses.

Another reason is that real estate can provide consistent returns. The yields from rents are consistent and add to capital gains from any rises in the value of a building – as well as rises in share prices. Global listed real estate has been one of the better returning asset classes over the past decade, delivering a 9.6% a year total return, outperforming both global equities and global bonds.

It delivered these higher returns with only marginally higher levels of volatility compared with equities. In addition it provides diversification benefits, since 1991 correlation with equities and bonds are 0.64 and 0.13 respectively, making it an essential component of a well-diversified investment strategy (UBS).

Is this performance sustainable?

The strong performance of the global real estate investment trust (REIT) sector is sustainable due to several reasons.

Demand - there is global demand for both yield and real assets. Liquidity is also important, given the need to live off investments post retirement. REITs are a logical investment to match ageing population demands requiring higher levels of income, lower volatility, higher transparency and liquidity.

Diversification of supply - in both existing listed real estate markets and new frontier markets we expect to see more property securitised. Over the past 18 years REITs have grown rapidly, from just four countries in 1994 to 22 countries in 2011, but still only below 10% of real property assets are listed on the public markets (UBS). REIT legislation is in place in a further 12 countries but yet to be actioned, so expect to see more opportunities, more markets and more diversity driving the market higher.

Inflation hedge - an increase of inflation will occur if there is political abandonment of austerity measures in favour of pump-priming the economies through the continued printing of money. This would lead to an outbreak of inflation. Due to the fact that REITs have real assets that are often linked to inflation on both the balance sheet and cash flow, REITs can offer an inflation hedge.

The best use of low interest rates

One of the best ways to tap into low global interest rates is to generate investment returns through logical but cautious spread investing. In December 2012, Simon Property Group issued $750m of five year debt at 1.5%, and can invest into a European development pipeline via its investment in Klepierre delivering 7.4% yield on cost.

There is an early trend building where well capitalised market leaders within the US deploy their low cost of capital advantage into Europe and Latin America, improving management, strategy and expertise, at an opportune early stage in the real estate cycle. As an example we have seen this happen with Simon Property Group in 2012 investing in the French listed Klepierre and we are already seeing positive performance results.

Which sectors where?

We favour the highest quality real estate companies in prime markets, such as London, Paris, New York and// 2 Tokyo, taking the view that prime real estate will outperform secondary through a real estate cycle.

Japan - We like the Abenomics Japanese reflation story and the many positive implications for all sectors within the Japanese real estate market. We believe this will include growth in the rents payable by tenants through inflation linked leases and an improving economy. In addition asset values are expected to grow as inflationary conditions return and yields compress, as the returns on risk free alternatives in Japanese government bonds yields get bid lower.

Europe - We see value in pockets of Europe, but in selective markets, such as West End London office, European malls and some deep contrarian value in continental offices.

Australia - We like Australia given its attractive current yield of 5.4% in FY14 (AMP Capital, 31 May 2013), which is:

  • Sustainable -it is supported by a sector wide earnings payout ratio of circa 80%, backed by contractual leases
  • Growing – it is common for Australian leases to include inflation linked annual increases in rent (c4%+ annual increases). We also see the Australian real estate market as a proxy for Asian growth and underpinned by quality companies, with >75% (by market cap) achieving a credit rating of BBB+ or better.

North America - In the US, the economic recovery is strong and we believe the consumer and housing recovery has further to go. Besides the strongest companies in the strongest markets such as Simon and Boston Properties, we have exposure to the many derivatives of a continued residential recovery through multi-family and aged care residential properties.

Latin America – Countries like Mexico are rapidly transitioning as dynamic real estate markets with strong risk adjusted returns following newly created REIT legislation. In fact, they have some of the strongest risk adjusted returns of any market today.

Asia – We have become more constructive on parts of the China real estate market and see substantial value in tier one cities, in both prime, rent generating assets and mixed use development pipelines that are in the process of construction.

 

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