Global Real Estate Securities April 2012 Review and Outlook
Cohen & Steers
May 18, 2012
Global Real Estate Securities April 2012 Review and Outlook
We would like to share with you our review and outlook for the global real estate securities market as of April 30, 2012. The FTSE EPRA/NAREIT Developed Real Estate Index had a total return of +2.3% for the month (net of dividend withholding taxes) in U.S. dollars. Year to date, the index returned +15.3%.
The global real estate securities market added to its strong year-to-date performance in April, meaningfully outperforming the broad equity market, which declined 1.1% as measured by the MSCI World Index. Positive returns in North America and Asia Pacific more than compensated for modest losses in Europe.
Concerns about Europe returned amid rising worries over Spain’s finances, signs of deteriorating growth across the Continent and an increasing austerity backlash expressed in regional elections. Even U.S. economic data, which had shown improvement in the first quarter, began to disappoint. On the positive side, slowing global demand helped to ease inflationary pressures, leading to expectations that policymakers would implement additional monetary easing and other stimulus measures.
North America had solid gains
U.S. REITs returned +2.9%, as measured by the FTSE NAREIT Equity REIT Index, benefiting from low borrowing costs, moderate inflation and strongly positive earnings results. Regional malls (+5.8%(see note) return in the index) performed well, led by owners of Class A properties, where tenant demand is the strongest and consumer spending remains healthy. Self storage REITs (+4.2%) also outperformed, after trailing in the first quarter.
Within the office sector (+2.9%), SL Green Realty was a noteworthy performer, rising 6% as vacancy concerns ebbed after it announced one of the largest leasing deals in Manhattan history with media tenant Viacom. Apartment REITs (+1.3%) were weighed down by disappointing guidance from Equity Residential, while the industrial sector’s performance (–0.3%) reflected a lackluster showing from ProLogis, whose portfolio includes land and buildings in Europe.
Canada (+3.6%(see note)) benefited from continued strength in its western provinces and access to low-cost financing. During the month, two joint ventures announced separate competing projects to develop outlet malls outside of Toronto, demonstrating the strong demand in the region and the attractive dynamics of the outlet business model.
Europe struggled as economic conditions worsened
The U.K had a modest total return (+0.4%), as inflation pressures intensified and the economy shrank for a second consecutive quarter. Retail property fundamentals remained challenged, while prime office markets such as London’s West End showed improvement.
France (–4.5%) struggled amid high unemployment and flat first-quarter GDP growth, as well as uncertainty surrounding its presidential election. We saw further evidence of a polarization between prime retail locations and secondary properties, although this was not reflected in April’s share-price performance. In the Netherlands (–6.2%), budget negotiations collapsed between coalition party members, as the country continued to grapple with debt issues that have put its AAA credit rating at risk.
Switzerland (+5.0%) had a strong return for the month, benefiting from its perceived status as a safe haven within the region, as well as its stable economy, with rising consumption trends supported by sustained high population growth. Sweden (+1.6%) also outperformed amid signs of improving domestic demand and exports.
Asia Pacific buoyed by Hong Kong and Australia
Hong Kong (+4.7%) gained as credit conditions continued to ease and leasing activity gained momentum. Top performers included retail landlords, which benefited from anticipation of a strong May during China’s golden week holidays. Legal concerns surrounding Sun Hung Kai continued to weigh on the company’s shares; the company’s co-chairmen were detained in late March on suspicion of bribery but have not yet been charged with any crime.
Australia (+5.6%) benefited from easing inflation and expectations that the central bank would cut interest rates, which it did following the month’s end. During the month, Dexus announced the sale of U.S.-based industrial properties for $770 million, using the funds to initiate a stock buyback and raise its dividend payout ratio.
Japan declined 4.1% in April after a stellar first quarter. Equities initially spiked when the Bank of Japan announced aggressive quantitative easing efforts to reverse deflationary trends, but fell back as the yen strengthened. Office vacancy rates improved slightly in March, although the dip was viewed as temporary.
Singapore (–2.3%) was weighed down by policy tightening related to inflation concerns. REITs were generally more resilient, led by more-cyclical names. Reports from property consultants suggested that retail rents held steady in the first quarter despite new supply scheduled for the second half of the year. Developers underperformed after a strong first quarter.
North America fundamentals on a slow but positive trajectory
We maintain our outlook of modest but steady U.S. economic growth in 2012 despite recent disappointing data points. In our view, such an environment should drive incremental gains in demand for commercial space. Furthermore, we believe low funding costs and a lack of new supply in most markets are likely to provide support to real estate fundamentals.
We continue to take a positive stance toward specific office markets that cater to life sciences, technology and media, including parts of the West Coast and Manhattan. We also favor prime retail owners, while staying cautious toward health care properties, suburban offices and secondary retail. We decreased our allocation to apartments on valuation concerns, as well as the prospect for increased competition from single-family home sales and rentals.
In Canada, we continue to favor companies across all property types with meaningful business in the western region. Despite rumblings of concern around the housing market, we believe a correction in home prices (which we view as likely) would have only a small effect on the country’s financial system as long as the jobs market holds up.
European economic challenges keep us focused on high-quality names
Our base-case scenario for Europe is a moderate recession, with strength in Germany and Scandinavia contrasting sharply with far more severe conditions in the southern region. We see meaningful economic headwinds over the foreseeable future as Europe attempts to bring its fiscal imbalances under control. Furthermore, unlike in many other parts of the world, inflation rates remain elevated (albeit slowing), giving the European Central Bank little room to cut interest rates.
Despite these challenges, we believe valuations for many listed real estate companies have reached levels that are likely too low on a relative basis. We continue to closely monitor macroeconomic developments, and remain focused on companies that we think are best positioned to shield themselves from the adverse effects of deleveraging. Specifically, we generally favor high-quality companies with strong balance sheets and relatively low cash flow multiples. We continue to like London offices and the Berlin residential market. We also favor landlords with prime retail assets in northern European markets, where consumer spending is relatively healthy.
Policy easing trends likely to benefit Asia Pacific
Hong Kong remains among the most attractive property markets in the world, in our view. While the economy is likely to decelerate further, we expect conditions to begin improving by the end of the year. We continue to favor prime retail landlords due to strength in mainland tourist spending, and we are also finding value in the office market. Within the residential market, mortgage spreads are stabilizing and developers are seeing a boost in sales volumes due to more-reasonable pricing. However, we expect the government to increase land supply in the coming years, which argues for some caution on residential development business models.
We remain underweight Japan based on relative fundamentals and business models. Demand for office space remains weak, although there are early signs of a bottoming in net effective rents. We are seeing relatively better resilience in the residential market, with condo sales buoyed by government incentives and low interest rates.
In Australia, the decision by the central bank to cut interest rates by a larger-than-expected 50 basis points on May 1 is, in our view, a good indication of its increasing comfort with inflation and a more-accommodative monetary policy. However, we remain cautious, as the broader economy has yet to benefit meaningfully from increased capital spending in the mining sector.
We have become more constructive toward Singapore, favoring cyclical sectors such as offices and hotels, which stand to benefit the most from a recovery in global demand. We view hotels as particularly attractive given tight supply conditions and growth in intra-regional travel. Among developers, our positioning reflects the diverging trends we see in the residential market favoring mass-market housing over luxury projects.
Sector returns as measured by the FTSE NAREIT Equity REIT Index.
Country returns are in local currencies as measured by the FTSE EPRA/NAREIT Developed Real Estate Index.
(c) Cohen & Steers