Cohen & Steers Global Real Estate Securities Strategy
Cohen & Steers
June 15, 2012
We would like to share with you our review and outlook for the global real estate securities market as of May 31, 2012. The FTSE EPRA/NAREIT Developed Real Estate index had a total return of –6.4% for the month (net of dividend withholding taxes) in U.S. dollars. Year to date, the index returned +7.9%.
Investment Review
Global real estate securities declined in May, as concerns
about the global economy intensified. Many headlines
focused on the rising risk that Greece could withdraw from
the euro, but the more worrisome developments were in
Spain, where rumors of bank runs fed speculation that bank
recapitalizations and possibly a bailout from the European
Monetary Union could be necessary. Adding to the generally
gloomy backdrop for equities were signs of a rapid slowdown
in China and disappointing economic data out of the
United States.
Investment capital flocked to perceived safe havens such as
the U.S. dollar, with yields on 10-year Treasury notes ending
at an all-time low of 1.59%. Oil prices sank nearly 20% in the
month, reflecting reduced expectations for global energy demand. On the other hand, falling commodity prices helped
ease inflation concerns, setting the stage for further rate cuts
by central banks.
Real estate securities outperformed local equities in nearly all major markets, benefiting in part from increased investment demand for income-producing assets in a lowyield environment. The flight to quality generally favored commercial property owners with low leverage, defensible cash flows and prime assets. In contrast, companies with properties in economically challenged markets generally underperformed.
North America declined amid diminished growth expectations
U.S. REITs returned –4.5% in May, as measured by the FTSE
NAREIT Equity REIT Index. Property types perceived to have
greater economic sensitivity were the poorest performers,
including industrial REITs (which had a –8.6%(1) return in the
index) and hotels (–7.7%). Prologis declined more than 10%
despite recent data suggesting that the company’s European
operations were performing well. Office REITs also struggled
(–6.2%), including SL Green, which underperformed despite
two large lease renewals in New York City.
Among regional malls owners (–5.2%), Simon Property Group was somewhat more resilient, but remained susceptible to reduced growth estimates despite its high-quality assets and fortress-like balance sheet. Apartment companies (–2.4%) outperformed, as employment growth—while modest at best over the past few months—was enough to keep the group’s fundamentals healthy. Health care REITs (–1.0%) also held up well, with investors willing to pay a premium for the group’s perceived stability.
Canada (–0.4%(2)) had only a modest decline, as investor confidence in its banking system helped offset global macro concerns. Western territories continued to see robust demand for commercial space, while in the East, efforts to capitalize on Canada’s outlet mall opportunity remained in full force. In a highly anticipated transaction, Dundee REIT and H&R REIT won the bid to acquire Scotia Plaza in Toronto, paying a record C$1.3 billion (US$1.2 billion), or approximately C$640 (US$620) per square foot.
Europe struggled as economic and fiscal conditions worsened
Despite the economic turmoil in Europe, overall returns for the region were only modestly negative in local currency terms, with the bulk of the net decline reflecting weakness in the euro and the pound relative to the U.S. dollar. (The euro would likely have declined further if not for efforts by the Swiss National Bank to maintain a floor on the euro-franc exchange rate.)
The U.K. returned –1.9% as economic output continued to decelerate. Great Portland Estates, which owns and develops properties primarily in London’s West End, was a standout, benefiting from the prospect of potentially strong development returns and letting performance.
In France (0.0%), Klépierre solidly outperformed, announcing it had issued €300 million (US$370 million) in debt through three private placements. The relatively low yield of the issues signaled that its cost of capital has decreased materially since Simon Property Group purchased a stake in the company. Germany (+5.8%) added to its strong year-to-date returns, with gains by residential companies offsetting declines among office REITs. The German economy has not been immune to the region’s woes, but remains among the best in Europe, with unemployment falling to a 20-year low.
Switzerland (+0.8%) saw substantial investment inflows due to the country’s relatively stable economy and conservative fiscal policy. In contrast, the Netherlands (–4.0%) underperformed amid concerns about its companies’ properties in Italy and Spain. Sweden (–3.0%) declined despite an economic environment that is meaningfully better than that of lower Europe.
Slowing global economy weighed heavily on Asia Pacific markets
Hong Kong returned –9.6% amid worries of a China slowdown. Both developers and REITs suffered, from higher-risk names such as Sino Land to the typically defensive Link REIT. Sun Hung Kai declined somewhat less, as its shares had already taken a hit following the bribery-related arrests (with no formal charges to date) of its co-CEOs in April. Notably, the company received approval to launch new residential projects, demonstrating its continued ability to operate in good standing with the government.
Japan (–10.3%) revised its first-quarter GDP growth estimate higher to 4.1% (annualized), with stronger-than expected contributions from post-quake reconstruction and consumer spending. However, slowing growth in the U.S. and China kept the yen on an upward trend, driving concerns about headwinds to future growth. Developers underperformed, while J REITs were generally more resilient.
Property stocks in Australia (–1.3%) were more resilient, although faltering economic growth and falling commodity prices led to a sharp decline in the Australian dollar. With price pressures easing, the central bank aggressively cut its benchmark rate by 50 basis points to 3.75%. REIT balance sheets remained in generally strong shape, while buybacks provided a floor to share prices.
Singapore (–3.8%) is among the most leveraged economies to global trade. REITs generally outperformed, led by less-cyclical names. Returns among developers diverged, with those focused on domestic markets doing better than those with China operations.
Investment Outlook
U.S. likely to continue on a slow recovery path
Notwithstanding the disappointing April employment report, we expect the U.S. economy to maintain a slow but steady recovery, allowing for incremental gains in tenant demand and continued low financing costs. Fundamentals in most sectors should also be supported by only gradual additions to supply, likely benefiting property-level cash flow growth.
Recent property transactions have provided confirmation of our view that certain stocks in the hotel and industrial sectors continue to offer good value. We also seek to maintain a defensive component in the portfolio. For this, we believe owners of high-quality malls are more appealing than the health care sector. The latter is relatively expensive as a group, in our view, even though it includes cyclical properties such as senior housing centers, which lease to private-pay tenants.
We maintain a favorable view of key office markets, including life sciences, technology and media, as well as New York offices broadly, while remaining cautious toward suburban office owners. Although we see some attractive qualities in the apartment sector, we have concerns based on valuations and the prospect of decelerating earnings growth.
European economic challenges keep us focused on high-quality names
We see recent volatility in European markets as an inevitable part of the process as policymakers work to resolve the structural issues underlying the euro crisis. Our base-case scenario remains one of moderate recession in the eurozone, with more severe contractions in the southern peripheral countries and slow-to-moderate expansion in the north. Public resistance to austerity may result in a greater policy emphasis on stimulus, although this is likely to push out budget targets for many countries.
We remain focused on companies that we believe are well positioned to defend against the adverse effects of government and consumer deleveraging. Specifically, we 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, as well as prime retail assets in northern Europe.
Asia Pacific opportunity remains largely a Hong Kong story
Hong Kong ranks among the world’s most undervalued property markets based on our NAV estimates, even considering the potential for further economic deceleration. We continue to favor prime retail landlords, although we view offices as increasingly attractive, with the market pricing in a rental decline that is likely too excessive. In the residential market, mortgage spreads are stabilizing and developers are seeing reasonable sales volumes due to more-reasonable pricing. However, we believe positive demand-side factors are likely to be offset by policy and supply risks in the near term given the transition to a new administration this year.
We have recently become more constructive regarding the Singapore market, favoring cyclical sectors such as hotels and offices, which stand to benefit from a recovery in global demand. We view hotels as particularly attractive given tight supply conditions and growth in intra-regional travel. Among developers, we believe the risk of tightening policies has been priced in by the market, and we remain positive on names with strong mass-market residential operations.
Japan continues to see challenging property fundamentals, although we believe the downside risk has moderated somewhat. While tenant demand for offices is tepid, we are seeing clear evidence of a bottoming in net effective rents. We are also seeing resilience in the residential market, with condo sales buoyed by government incentives and low interest rates.
Australia’s central bank appears in our view to be increasingly comfortable with an easing policy stance, evidenced by its additional cut of 25 basis points in early June. However, organic income growth for property companies remains subdued, and acquisition opportunities are limited. While we believe capital values are well positioned to benefit from a global recovery, discounts for the sector have narrowed (based on our estimates), and we continue to see better value elsewhere.
Past performance is no guarantee of future results. The performance information in the preceding commentary does not reflect the performance of any fund, product or account managed or serviced by Cohen & Steers. The views and opinions in the preceding commentary are as of the date of publication and are subject to change. There is no guarantee that any market forecast set forth in this presentation will be realized. This material should not be relied upon as investment advice, does not constitute a recommendation to buy or sell a security or other investment and is not intended to predict or depict performance of any investment.
(1) Sector returns are measured by the FTSE NAREIT Equity REIT Index.
(2) Country returns are in local currencies as measured by the FTSE EPRA/NAREIT Developed Real Estate Index.
(c) Cohen & Steers
