Cohen & Steers International Real Estate Securities Strategy
Cohen & Steers
June 15, 2012
We would like to share with you our review and outlook for the international real estate securities market as of May 31, 2012. The FTSE EPRA/NAREIT Developed ex-U.S. Real Estate Index had a total return of –8.0% for the month (net of dividend withholding taxes) in U.S. dollars. By comparison, U.S. REITs returned –4.5% for the month, as measured by the FTSE NAREIT Equity REIT Index. Year to date, the indexes returned +7.3% and +8.8%, respectively.
Investment Review
International 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 low-yield 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.
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%(1) 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. Late in the period, Deutsche Wohnen announced that it won a bid to acquire a portfolio of 23,500 residential units from BauBeCon, which had entered receivership with Barclays in 2011. The €1.2 billion (US$1.5 billion) deal will likely provide an immediate boost to Deutsche Wohnen’s earnings, and will significantly expand its presence in Berlin and other metro areas.
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. Offices in metropolitan markets continued to see strong net lettings driven by the local service economy.
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 Properties 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-chairmen 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. Office vacancies rose slightly in May, but less than the market had feared.
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. In retail, fundamentals continued to show divergence between stable prime assets and deteriorating secondary markets.
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.
Canadian property fundamentals remained strong
Canada (–0.4%) outperformed, 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 C$640 (US$620) per square foot.
Investment Outlook
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.
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