Demand for physical property has shown little sign of diminishing in 2018 despite interest rates rising in the US and the UK and the end of quantitative easing (QE) coming into view in Europe. Concerns are emerging about growing global economic and financial risks, and in such an uncertain context for investors generally, we believe the liquidity advantages of the public markets should gain greater relevance for real estate investors. This is particularly so as listed real estate is trading at potentially attractive discounts and offers instant access to high-quality assets in the most prominent global locations.
We are now nine years into a recovery in real estate markets and have probably hit the peak of the cycle. Certainly, listed real estate companies are telling investors that growth from leasing is slowing and that, while occupancy levels in gateway cities are high, property yields have probably bottomed out.
Go with the flow – discounts to NAV could help
Most major economies are still experiencing employment growth, but increasingly, there are worries across most sectors of the economy that wage growth will start to hit company profits. Property prices in the direct markets are high as relatively cheap debt and low global bond yields have continued to generate flows into the sector.
As Exhibit 1 illustrates, property yields globally are well below trend. Moreover, property yields would normally be expected to rise as central banks tighten policy. Public markets have anticipated this growth slowdown in property markets as well as a tightening monetary policy: the listed real estate sector sold off briskly as we moved into the fourth quarter. REITs are now trading at substantial – potentially attractive – discounts to net asset value in most markets.
Exhibit 1: Prime property yields in Q2 2018 (in local currency)
Exhibit 2: Discounts to NAV Q3 2018 (in local currency)
Source: EPRA, UBS, Green Street, JLL, BNPP AM estimates. Trend = 10-year trailing average. Property yields – prime net yields for a mix of office, retail and industrial commercial properties in capital and major cities. The value of your investments may fluctuate. Past performance is no guarantee of future returns.
So, at this stage of the cycle, it could be puzzling that billions are still waiting to be invested in direct markets given the extremely high price of real estate in many markets. But fundraising remained robust throughout the first half of 2018, with capital dry powder held by real estate companies standing at USD 278 billion at the end of June (Preqin, July 2018). Clearly, a lot of this money has been collected historically and has yet to be invested. Investors appear to be taking the view that interest rates will not rise precipitously in the absence of significant global inflationary pressures.
Inflection point should favour listed real estate
Nonetheless, we believe we are approaching an inflection point in property and capital markets. And turning points in a cycle are usually accompanied by a spike in volatility. As such, investors buying buildings or into non-listed investment vehicles risk doing so at a time when prices, occupancy rates and rents have peaked. The costs of making an investment in a building at this stage in the cycle and then wanting to exit could be substantial, given the time and money costs involved in buying assets such as property due to its large and illiquid nature.
While some may decide to wait, those that need to invest in real estate could find an opportunity in the listed sector. Buying into real estate in the form of a tradeable security can give investors the same underlying exposure as investing in direct markets. Listed real estate, however, means exposure to many thousands of buildings rather than a single asset or a basic portfolio of buildings. Transactions take considerably less time and involve less money. Typically, listed real estate portfolios invest in higher quality property in different locations, bringing investors a quality bias and diversification benefits. Equally, at a potential watershed moment for markets, it is typically considerably easier to trade in and out of securities, even when markets are selling off. By contrast, buying and selling individual assets – buildings, homes – can take months and in some cases, years.
It is like hot cakes: buying and selling a listed REIT portfolio
To illustrate the liquidity differences between listed real estate and direct real estate, we examined how long it would take to dispose of a hypothetical EUR 1 billion direct property portfolio compared with the liquidation of a similar-sized global-listed real estate portfolio. Jones Lang LaSalle Inc. (JLL), a professional services and investment management company specialising in real estate, provided the direct market data required for this exercise. This consisted of EUR 1 billion of prime modern properties: all were class A properties located in major global or mega cities, with 45% in North America, 40% in Asia Pacific and 15% in Europe. The differences are stark. While disposing of a listed REIT portfolio would take nine days, it could take an average of six months or more to sell a similar-sized portfolio of buildings in current market circumstances.
Exhibit 3: Average number of days to liquidate a EUR 1 billion global portfolio of listed and direct real estate in similar market conditions as those in 31 August 2018
Data source: Jones Lang LaSalle Inc., FactSet, August 2018. This is not intended as a solicitation to purchase these securities, nor does it constitute any investment advice or recommendation. The value of your investments may fluctuate. Past performance is no guarantee of future returns.
Clearly, there is still an attractive spread of real estate yields over government bonds, averaging 200bp globally. This is appealing to capital globally. But the risks are increasing that we are entering the latter stages of the cycle and as such, investors should be considering whether to focus on liquidity while maintaining their real estate exposure. Investing in listed property companies gives this kind of flexible access to high-quality assets, while providing portfolio diversification and the ability to adjust exposure efficiently and effectively when needed.
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