Global Real Estate Securities Performance Review and Market Outlook

Transcription

1 By Corrado Russo, Managing Director, Investments & Global Head of Securities, Timbercreek Asset Management EXECUTIVE SUMMARY Global economic conditions continued to improve throughout 2013 culminating with the U.S. Federal Reserve formally beginning the process of winding down its quantitative easing measures. In the United States, demand for commercial real estate has broadened as consumer spending and job growth strengthened. In Europe, U.K. unemployment declined, resulting in a recovery in London s office market. On the Continent, tail risk meaningfully decreased as central bank policies remain accommodative while the economy is finding its footing despite soft economic conditions. In Asia, strong policy action in Japan resulted in a resurgence in confidence leading to an expansion in transaction activity, which is driving asset values higher. In Australia, economic growth is sub-optimal yet accommodative central bank policy is positively impacting consumer sentiment while Singapore and Hong Kong remain beneficiaries of broader growth across Asia. Despite a synchronized global expansion materializing across the U.S., Europe and Asia, global real estate securities meaningfully underperformed global equities by over 1,900 basis points in 2013 as the asset class seemingly moved inversely to changes in bond yields. We believe the sector s underperformance plus improved economic conditions creates opportunity and we look for this underperformance to reverse in We expect a 12% to 14% total return from global real estate securities in Our expected return consists of 9% to 10% in capital appreciation and 3.5% to 4.0% in dividend yield for the overall global REIT market. Capital appreciation is driven by an expectation of 6% to 7% earnings growth, the narrowing of discounts to NAV and modest changes in valuation. Growth is being led by the United States and United Kingdom, the highest yields are expected in Singapore, Australia and Canada and the most attractive valuations are expected in Australia, Hong Kong, the United States and France. As we interpret our key indicators heading into 2014, the global real estate market screens attractive across most metrics. Demand Supply Growth Valuation United States Canada United Kingdom Continental Europe Hong Kong Japan Singapore Australia THIS DOCUMENT IS FOR PROFESSIONAL AND QUALIFIED INVESTORS ONLY AND IS NOT TO BE USED BY OR FOR RETAIL INVESTORS This document is for informational purposes only and is not an offer or solicitation to deal in securities. Any opinion or estimate contained in this document is made on a general basis and is not to be relied upon for the purpose of making investment decisions. The statements made herein may contain forecasts, projections or other forward looking information regarding the likelihood of future events or outcomes in relation to financial markets or securities. These statements are only predictions. Actual events or results may differ materially, as past or projected performance is not indicative of future results. Readers must make their own assessment of the relevance, accuracy and adequacy of the information contained in this document and such independent investigations as they consider necessary or appropriate for the purpose of such assessment. This document does not constitute investment research. Consequently, this document has not been prepared in line with the requirements of any jurisdiction in relation to the independence of investment research or any prohibition on dealing ahead of the dissemination of investment research. Any research or analysis used in the preparation of this document has been procured by Timbercreek for its own use. The information is not guaranteed as to its accuracy. 1

2 2013 YEAR IN REVIEW North America 2013 was a challenging year for the U.S. REIT market as rising bond yields, tapering of Fed stimulus and a government shutdown in Washington created headwinds for the sector. U.S. REITs generated a +2.5% total return in local currency in 2013, materially underperforming general equities (as defined by the S&P 500 Index), which generated a strong +32.4% total return in local currency. Additionally, U.S. REITs underperformed the global real estate market, which generated a +4.4% total return in USD. Despite the challenging performance environment, real estate fundamentals improved throughout the year. U.S. REIT Occupancy is Improving Those property types poised to experience a disproportionate benefit from improving GDP, such as hotels, self-storage and industrials, outperformed in 2013, while property types less tied to improvements in GDP or that typically improve later in the cycle (such as healthcare, manufactured housing and office) underperformed in These trends started to ease in the fourth quarter as self-storage companies underperformed (-6.4% in local currency) and office companies outperformed (+1.1% in local currency). After several years of strong market performance, Canadian REITs suffered their first negative annual return since Canadian REITs generated a -5.6% total return in local currency in 2013, meaningfully underperforming the global real estate market. Canadian REIT performance languished due to concern over the impact rising bond yields would have on real estate prices as well as the market shifting its attention towards growth and away from yield. Large caps outperformed small caps and companies that own hotel and healthcare properties outperformed companies that own multifamily properties Canadian REIT Performance Source: Citi Research Demand for commercial real estate became broader, new supply was modest and occupancies and rents increased for most property types. Aggregate Construction Starts at Very Low Levels Source: Thomson One, FTSE EPRA NAREIT and RBC Capital Markets Source: CBRE and Citi Research 2

3 Europe Prime vs. Non-Prime Total Return Index In 2013, the European real estate market delivered a positive return of +10.8% in EUR terms, meaningfully outperforming the global real estate market by approximately 1,100bps. Country level performance varied with the U.K. experiencing the strongest returns up +25.0% in GBP, while Germany (-2.4% in EUR terms), Switzerland (-11.8% in local currency) and Norway (-12.6% in local currency) lagged. The Netherlands and France delivered modest returns, +6.9% and 7.4% in EUR terms, respectively. The low interest rate environment in Europe combined with slow growth supported ongoing accommodating monetary policy which created a favorable environment for real estate and stocks. Markets continued to move off the bottom as valuations screened attractive. Since the financial crisis, the gap between primary and secondary assets has widened. Source: CBRE, Kempen U.K. Prime vs. Secondary Yields (%) In our view the reasons for these developments were twofold; first, the regulatory tightening of banks caused a shortage of debt related funding resulting in a higher cost of capital for assets situated in less attractive locations. Second, weaker economies and secondary locations experienced a material pullback in tenant demand resulting in tenant delinquencies and decreasing rents. However, confidence grew throughout the year as debt funds stepped in and provided capital to these secondary assets, leading to a recovery in price and sentiment. In terms of the listed sector, the strongest performers in 2013 were companies that were able to address issues such as secondary quality portfolios, overleverage, shareholder structure or management. Source: Bloomberg, J.P. Morgan Cazenove European capital market activity increased during 2013 as a rise in bond issuances allowed established companies to reduce their cost of debt. The most prominent example was Unibail, which issued a five year bond in October with a coupon of 1.875%. Two years ago, Unibail issued a five year bond at a 3.875% coupon. Convertible bonds also gained traction with a high profile German residential company issuing a convertible note at a 1% coupon. In addition to higher bond issuances, M&A activity returned to the sector as several takeovers/mergers occurred during the year. We expect M&A activity may potentially increase in IPO activity of German multi-residential companies was an active part of the market throughout the year as investor interest in this sector remained strong. High quality European retail centers in superior locations continued to perform well despite challenging economic conditions and accelerating internet sales. Demand for office space was still limited but pockets of growth emerged in the technology, government and business services sectors. Logistic experienced a recovery but still lags behind what we have seen in the U.S. and elsewhere. Finally, residential rental properties were in high demand but remain a limited sector in the European listed market. Finally, a plethora of alternative debt lending became even more evident in the U.K. accelerating the rotation from prime to secondary locations in London, indicating that the economic and real estate recovery is well under way. Asia In 2013, Asian real estate markets generated widely diverging results with Japan strongly outperforming (+60.4% in local currency), Australia modestly outperforming (+7.2% in local currency) and Singapore (-7.4% in local currency) and Hong Kong (-9.3% in local currency) lagging. 3

4 In Japan, strong policy action resulted in a resurgence in confidence leading to an expansion in transaction activity, resulting in falling cap rates driving asset values higher. Annual DPU Growth Rate Tokyo Cap Rates Source: Citi Research Finally, the successful Olympic bid served as a catalyst for the market and should have a positive impact on land prices over the coming years. Source: UBS, Japan Real Estate Institute The Japanese Real Estate Investor Survey Japanese real estate companies benefitted from a decreasing cost of capital and a more constructive outlook for growth. Most took advantage of lower capital costs by extending their debt maturity profiles. External growth accelerated in 2013 and equity financings rose to a record high as companies took advantage of rising share prices to acquire assets. Historical Equity Issuance by JREITs (including IPOs) Hong Kong underperformed in 2013 as concerns regarding growth in China and rising interest rates caused the market to lag, in our view. Fundamentally, the market was mixed. After experiencing remarkable levels of growth in rents and capital values in the years following the financial crisis, the office market continued to muddle along in Although supply in Hong Kong s CBD is minimal, the lack of demand from the financial services sector caused rents to weaken marginally. Overall Grade A Office Rental Index Source: Citi Research Due to the fact that most Japanese real estate companies trade at a premium to NAV, acquiring assets and financing the transaction through new equity proved accretive to both earnings and DPU. Source: JLL, BofA Merrill Lynch Global Research Retail in Hong Kong performed well with discretionary retail continuing to benefit from Chinese tourism while non-discretionary retail was augmented by low vacancy rates and a healthy local consumer. 4

5 Singapore lagged its global peers in Due to the linkage between Singapore and U.S. interest rates and the relatively short duration of debt utilized by SREITs, volatility reared its ugly head in May and June after the Fed announced its intention to taper its quantitative easing measures. From the peak in May to the trough in June, the market declined by approximately -17.4%, in local currency. Despite the challenging performance environment, Singapore real estate fundamentals were, in our view, strong in The RBA cut its overnight cash rate by 50bps over the course of the year, leaving the all-in rate at 2.5% as of yearend. We saw the beginnings of a housing market recovery underpinned by the decline in interest rates, as well as strong investor demand and improved affordability. Medium Dwelling Price Lift from Recent Lows (to Sept 13) Office Take-up vs. GDP Growth Source: RPData Rismark, BofA Merrill Lynch Global Research The last two months of the year saw a high level of equity issuances which weighed on the sector, as well as the continued rise in bond yields, with the 10-year AU government bond yield reaching 4.4% Outlook Source: Deutsche Bank, Singstat, URA We expect GDP to increase by more than 3.5% in 2014, driving positive net absorption across the industrial, office, and retail sectors while pushing rents upward in all three sectors. Australia was a stock pickers market in 2013 with a 110% variation in returns from the weakest to the strongest performer; with almost all delivering a positive return. Generally, the smaller caps, M&A targets and the residential REITs outperformed while office and retail REITs underperformed. The improving cost of capital and challenges in securing quality assets inevitably led to a greater focus on M&A opportunities. North America In 2014, we believe the macroeconomic back drop becomes more favorable for U.S. REITs. Bond yields are now at a level that is more reflective of current economic conditions, the Federal Reserve has begun its tapering process, providing investors with the visibility and transparency that was lacking in 2013 and Washington has agreed to terms on a budget for funding the government through Finally and most importantly, we expect the U.S. economy to strengthen further, providing a positive back drop for real estate fundamentals. As economic conditions accelerate, we expect market rents to rise, net absorption rates to increase, occupancies to continue to grow and supply to remain modest as sourcing construction financing for new development projects remains a challenging endeavor for most private enterprises. Year Source: REIS, J.P.Morgan Vacancy Rate U.S. Annual Vacancy Rates and Effective Rent Growth by Property Type Multifamily Office Industrial Retail Change in Effective Rents Vacancy Rate Change in Effective Rents Vacancy Rate Change in Effective Rents Vacancy Rate Change in Effective Rents % 2.4% 17.4% 2.0% 10.9% -0.2% 11.0% -0.1% % 3.9% 17.1% 2.0% 10.0% 1.7% 10.7% 0.5% 2013E 4.1% 3.2% 16.8% 2.3% 9.4% 2.4% 10.4% 1.4% 2014E 4.2% 3.3% 16.5% 3.4% 8.9% 2.8% 10.1% 2.2% 2015E 4.4% 2.9% 16.1% 4.0% 8.4% 3.1% 9.8% 2.9% 5

6 The end result of this positive dynamic will be healthy earnings growth that in our view should serve as the catalyst to drive stock prices higher throughout In Canada, we believe the pullback in 2013 provides an opportunity to accumulate shares in companies that exhibit attractive valuations, good growth prospects and trade at discounts to our forwarding looking NAV. Group Average Premium / (Discount) to Estimated NAV GDP Growth Forecasts Country 2014E 2015E Sweden 2.40% 2.60% Germany 1.70% 1.90% France 0.80% 1.60% Italy 0.50% 0.90% Spain 0.60% 1.20% Netherlands 0.40% 1.00% Belgium 1.00% 1.50% Austria 1.60% 1.80% Greece 0.00% 1.40% Finland 1.20% 1.60% Portugal 0.50% 1.00% Ireland 1.90% 2.20% Switzerland 2.10% 2.10% Source: DataStream, Bloomberg, Kempen Source: Thomson One, RBC Capital Markets Overall economic conditions remain stable with GDP expected to increase in the 2.0% to 2.5% range and thus supportive of real estate fundamentals. We expect net operating incomes to grow in-line with inflation (2% to 3%), earnings growth in the mid-single digit range (circa 5%) and companies to take advantage of their access to capital by acquiring properties that are accretive to the bottom line. Combined with an average dividend yield of 5.75%, we believe the Canadian REIT market is poised to reverse its 2013 underperformance. Europe We expect alpha will be generated through stock selection in 2014 with a bias towards U.K. companies that have good growth and value add potential and Continental European companies that trade at an attractive discount to NAV with a clear catalyst to rerate the stock price. In the U.K., yield compression from low interest rates and central bank intervention seems largely to have run its course, therefore, we believe companies that can produce growth organically and have locked in their debt costs for the next several years will outperform. Listed real estate companies in Continental Europe will likely be faced with less risk of increasing cost of capital than the U.K., however this will be commensurate with less growth potential. Companies in Germany will benefit from strong demand while in the Nordic countries, we expect to see attractive opportunities with decreasing unemployment and improving retail spending, especially in prime locations. From our perspective, investments in struggling markets and companies undergoing restructuring are opportunistic but still need to be chosen very selectively. A lack of credit to both households and businesses is likely to hamper growth prospects going forward, especially in the South. Retailers are still consolidating to the most attractive locations and office demand remains patchy. Nevertheless many of these fears seem to be priced in. Asia In Japan, the outlook overall is positive, notwithstanding the potential threat of short term price swings. Although stocks are typically trading above NAV, we believe premiums decline primarily because of NAV growth, rather than declining stock prices. The consumption tax hike could pose a drag in the 2H14 given 60% of GDP is consumer related. Further monetary easing by the BoJ should be a positive driver for JREITs, offsetting the potential negative impact of the consumption tax. A weaker Yen should benefit manufacturing and rising construction costs will likely limit new development. With the office vacancy rate for Tokyo s 5 central wards approaching 7%, rental growth is becoming more likely. 6

7 Vacancy Rate Forecast for Tokyo Central 5 Wards Hong Kong Property Retail Rental Growth and Sales Volume Source: Rating and Valuation Dept. CEIC, Citi Research Source: Miki Shoji, Barclays Research Furthermore, transactions of large commercial properties in Tokyo and additional infrastructure spending surrounding the Olympics could serve as a positive trigger. We are most constructive on the office and industrial markets and less constructive on rental housing. In Hong Kong, we believe valuation is attractive with the listed real estate companies trading at higher discounts to NAV than their long term average. However, uncertainty over the trajectory of growth in China remains an overhang for the market. Hong Kong Property NAV Discounts These companies have positive market-to-market rental spreads embedded in their portfolio, provide more certainty with respect to future growth and valuations are more attractive on a relative basis. We believe Singapore has the potential to reverse its underperformance in Valuation is attractive and the country is uniquely positioned to benefit from global growth. Although capital flows have the potential to create volatility, we believe companies that pay a high current income and own quality assets should provide a buffer. We are more constructive on commercial REITs relative to developers as the government s tightening measures could lead to declines in residential prices, resulting in contracting volumes and margins. Quarterly New Home Sales and Re-Sales Source: Bloomberg, Citi Research Although we expect global growth to be positive, the Hong Kong office market is still working through some issues created during the boom years and in order for rents to rise, the financial services sector needs to expand. Moreover, we believe uncertainty around China s growth rate will impact the IPO market in Hong Kong, further increasing uncertainty. We believe the better risk-adjusted returns are in companies that own assets focused on nondiscretionary retail. Source: Deutsche Bank, URA We believe SREITs with in-place rents below market can drive outsized internal growth and serve as a catalyst for the shares. We are most positive on the industrial and office markets and less constructive on the residential market. 7

8 In 2014, the Australian economy is likely to grow at a below optimal pace as the non-mining sectors struggle and unemployment continues to rise. Further domestic cash rate cuts may materialize if growth doesn t. We expect the Australian housing market recovery to continue, with building approvals and prices up strongly from their lows, translating to higher earnings for the REITs with residential exposure. The decline in interest rates in 2013 has resulted in a recovery in consumer sentiment over the past 12 months which is a positive signal for retail sales. Consumer Confidence and Retail Sales CONCLUSION To reiterate, we expect a 12% to 14% total return from global real estate securities in Our expected return consists of 9% to 10% in capital appreciation and 3.5% to 4.0% in dividend yield. Capital appreciation is driven by 6% to 7% earnings growth, the narrowing of discounts to NAV and modest changes in valuation. We believe that growth is being led by the United States and United Kingdom, the highest yields are in Singapore, Australia and Canada and the most attractive valuations are in Australia, Hong Kong, the United States and France. Potential negative risks include slower than expected growth in China which would negatively impact Hong Kong, an acute rise in interest rates in the U.S. which would negatively impact Singapore and the United States, a cooling of demand for condos in Canada resulting in slower economic growth, the consumption tax hike in Japan negatively impacting consumer spending, the Australian Dollar depreciating more than expected thus negatively impacting residential sales and renewed political and/or monetary policy instability in Europe. Source: WBC-MI, ABS, BofA Merrill Lynch Global Research With retail leading indicators improving, we believe retail REITs will likely see releasing spreads stabilize and the growth outlook improve in the latter half of the year. We feel that office fundamentals will remain weak in 2014 with limited near-term supply being matched by subdued tenant demand, although we should continue to see upward pressure on valuations. Those A-REITs with fund management platforms are in a position to drive earnings growth by capturing the increased investor demand for unlisted property assets. We are most constructive on companies with residential and retail exposure. Potential upward surprises include economic growth in Europe increasing faster than expected, resulting in a broadening demand for commercial real estate, interest rates in the United States remaining flat or only modestly rising, which would prove positive for future refinancings, M&A activity in Canada increasing, growth in China and inflation in Japan accelerating above expectations, employment growth in Australia recovering driving office rents higher and acquisition activity in Singapore accelerating allowing the listed REITs to drive earnings higher. For More Information Contact Toronto New York Zurich London 1000 Yonge Street, Suite Park Avenue Feldeggstrasse Kensington High St. Toronto, Ontario, Canada 17 th Floor 8008 Zurich, Switzerland London, UK W8 4SG M4W 2K2 New York, NY Tel: Tel: Tel: Tel: Toll Free: