Global Real Estate Securities - January 2012 Review & Outlook
Cohen & Steers
February 21, 2012
We would like to share with you our review and outlook for the global real estate securities market as of January 31, 2012. The FTSE EPRA/NAREIT Developed Real Estate Index had a total return of +7.7% for the month (net of dividend withholding taxes) in U.S. dollars.
Global real estate securities rallied along with stocks broadly in January amid an easing of macro risk concerns. Positive developments in Europe significantly reduced the risk of a liquidity crisis, while data from China suggested the country was successfully navigating a soft landing to its economy. Meanwhile, the U.S. economy continued to show evidence of modest yet self-sustaining growth.
U.S. REITs had a total return of +6.5% as measured by the FTSE NAREIT Equity REIT Index. In addition to generally better-than-expected economic data, REITs benefited from the Federal Reserve’s announced intent to keep interest rates at near-zero levels through at least 2014 (out from its prior 2013 estimate). This sent a strong signal that funding costs would remain low.
Cyclical and higher-risk companies outperformed
All U.S. property sectors advanced in January, led by a rebound in cyclically sensitive sectors such as hotels (+10.9%() total return in the index) and industrial REITs (+10.4%). In contrast, defensive-oriented sectors underperformed, including self storage (+4.5%) and health care (+4.6%). Apartment REITs (+3.9%) had relatively modest gains amid concerns that improving sentiment in the single family housing market could lead to softer demand for rental properties.
Within the property sectors, companies with lower-quality assets and greater leverage generally outperformed, as risk factors associated with these companies diminished along with the better economic backdrop and low borrowing costs. For example, in the office sector (+7.9%), companies with assets in suburban (high cap-rate) markets did substantially better than their urban-focused (low cap-rate) peers, which have superior outlooks and lower cost of capital.
Canada (+3.4%( )) had a relatively modest gain as investors favored less-defensive markets. In news, Dundee REIT announced that it would purchase Whiterock REIT, an owner mostly of office buildings in Ontario, for C$582 million—a 14% premium to the previous day’s close. The deal combines two prominent REITs and suggests a positive development for real estate valuations.
Nearly all European markets advanced
A new program from the European Central Bank (ECB) was a major catalyst for the recovery in European—and global—markets. In December, the ECB announced repurchase operations that would allow virtually any European bank to receive low-cost three-year loans using very flexible collateral requirements, including risky sovereign and commercial debt. In a positive, related development, some banks used new funding to purchase the debt of Italy, Spain and other issuers, helping to bring yields down.
Real estate companies in the U.K. had a total return of +5.4%, lifted by the improving financial environment in the rest of Europe. The best performers included companies with significant portfolios in London’s West End, where fundamentals remain relatively strong, reflected in a 4% vacancy rate compared with a 5% long-term average.
In France (+5.4%), Gecina outperformed, having made excellent progress in its plan to dispose of targeted assets. The diversified property owner agreed to sell 10 residential buildings to a French institutional group for €395 million. The transaction is a significant early step in the company’s goal to sell €500 million in residential assets in the first half of 2012.
The Netherlands also returned +5.4%. Corio and Eurocommercial Properties both had strong gains. They have assets in Italy and Spain, and benefited disproportionately as perceived risk diminished. German real estate stocks (+0.6%) had softer performance, reflecting lackluster returns from Alstria Office and residential owner Deutsche Wohnen, two of the market’s largest constituents. Switzerland (–0.7%) had a slight loss as investors rotated away from safer havens in the period.
Asia Pacific bounced back
Japan (+6.5%) participated in the rebound, with developers and certain large office landlords recovering from a poor December. The market advanced despite a lackluster economic environment. Fourth-quarter GDP contracted an annualized 1.4%, with exports hampered in part by strength in the yen. December unemployment ticked up to 4.6%, although household spending was steady.
The rally in Hong Kong (+13.4%) was paced by developers, which outperformed landlords by a wide margin. Economic data reported in the month showed positive but moderating growth; GDP grew 5% in 2011, compared with a 7% expansion the previous year.
Australia (+5.6%) benefited from good performance from Westfield Group and Goodman Group. Both companies have significant property businesses outside their local markets and benefited from the improved global macro environment. In Singapore (+11.4%), developers rebounded after performing poorly in December, when an announcement of restrictive residential policies weighed on share prices.
We are encouraged by the recent trend of U.S. economic data showing measured improvement, including steady employment gains. With funding costs remaining low and demand showing signs of strengthening, we believe U.S. real estate fundamentals will continue to gradually improve in 2012. Importantly, new supply remains scarce in most sectors, due in large part to banks’ continued reluctance to finance speculative development projects.
We have become more constructive regarding the growth potential of key U.S. office markets, including life sciences, technology and media, while finding increasing value in New York offices. We continue to favor prime retail owners, while staying cautious toward health care properties, suburban offices and secondary retail.
A selective approach to Europe
Recent initiatives to address the sovereign credit crisis appear to be having a meaningfully positive effect on credit conditions across Europe. Importantly, the ECB’s long-term repurchase program has given banks vital breathing room to recapitalize. While we are cautiously optimistic, we remain vigilant to the potential risks and have a keen eye on Greece, which is engaged in ongoing negotiations with international lenders.
We remain selectively positive on the U.K. Although we are cautious on U.K. consumption trends, we favor REITs with sensible development strategies that own prime retail locations or West End offices. We also favor Scandinavia, which should benefit from northern Europe’s relatively healthy economies, more stable banking systems and lower interest rates.
We have a constructive view of France’s prime retail markets, but we expect growth to be modest and largely derived from rent indexation and debt cost reduction.
Conditions within Asia Pacific are encouraging policy easing
Hong Kong’s economy is likely to moderate further, although renewed liquidity in China could create select pockets of strength. The prime retail sector stands to benefit most from mainland tourist spending, but nationwide sales growth may slow due to tempering domestic consumer confidence.
We remain underweight in Japan, as a deflationary environment is likely to continue, putting pressure on real estate values. However, expectations of improving condo sales due to incentives and low interest rates may benefit developers on a relative basis.
In Australia, lower lending costs and falling inflation are likely to result in lower cap rates and higher property values. We expect cyclical sectors to recover only gradually, however, given still-challenging macro headwinds. The Reserve Bank of Australia has shifted its stance from restrictive to neutral, and we believe it will continue to loosen policy as required by the sluggish domestic economy.
In Singapore, we are more cautious on offices due to a less favorable supply picture. Hotels should fare better due to tighter supply, and demand that is more dependent on intra-regional travel. We expect retail to be resilient due to robust domestic consumption, while longer lease structures of industrial portfolios should help protect rental downside.
(c) Cohen & Steers