Global real estate fund managers discuss Mexico, the future of European real estate, investing in China and more.
Published in the September/October 2014 issue of REIT magazine.
The global commercial real estate markets proved to be volatile waters to navigate in 2013. However, investors have found smoother sailing so far in 2014.
Through the first eight months of the year, the FTSE EPRA/NAREIT Global Real Estate Index produced total returns of more than 14 percent, up from 2.24 percent for the entirety of 2013. The Americas and Asia/Pacific regions appear to have bounced back from flat performances a year ago, while Europe is holding steady with double-digit returns.
How happy are global real estate investors with the rebound? What do they expect next? What are the market trends that bear watching?
NAREIT spoke with five fund managers to find out their thoughts on the latest developments in global real estate investing:
- Steve Buller, Portfolio Manager, Fidelity Investments
- Jon Cheigh, Portfolio Manager, Cohen &
- Steers Capital Management
- Scott Crowe, Managing Director, Resource Real Estate
- Daniel Pine, Managing Director, Global Head of Forum Securities Ltd.
- Charles Wong, Head of Asian Listed Real Estate, AMP Capital Investors
REIT: The REIT approach to real estate investment continues to spread worldwide, but are we approaching a limit to that growth?
Scott Crowe: There’s a limit to everything, but I still think we’re in the earlier stages of this securitization of real estate. What is true is that REITs are no longer an esoteric part of the market. REITs are a large, successful way for every investor to access the returns in commercial real estate, the caliber of the companies, the caliber of the analysis, the transparency—the REIT industry is very well accepted.
The idea isn’t new anymore, but there’s still a long way to go until we’ve exhausted the possibility of REITs securitizing underlying real estate markets.
Steve Buller: No, it has not reached its growth limit. Although almost every major country in the world has a REIT structure in place, we still see tremendous room and growth for the securitization of real estate; that is, the transformation of ownership from private owners to publicly traded REITs. This transformation is occurring due to better liquidity and transparency of a REIT structure.
Daniel Pine: Multiple tailwinds continue to support the expansion of a global REIT approach to real estate investing. Acceptance of REITs as a proxy for private real estate coincides with a secular migration of capital from defined benefit into defined contribution programs. Transparency, liquidity and daily valuation of stock exchange-listed real estate fit well within the regulatory constraints of defined contribution plans.
As a result of such significant capital commitment to listed real estate, established REIT regimes continue to evolve in the developed markets, and many emerging markets are taking necessary steps toward creating REITs.
REIT: Are there any particular regions or sectors around the globe that don’t have REITs but could be particularly amenable to that form of real estate investment? Or perhaps an existing REIT regime in need of an overhaul?
Jon Cheigh: From a global perspective, the REITs that you see in Asia can be equipped to do more. They can be self-managed and have that incentive structure that we’re more familiar with here in the U.S.
Buller: Brazil has many listed property companies, but not a REIT structure. A tax-transparent REIT structure could enhance the listed property sector in Brazil.
On a different note, the Philippines have a REIT structure, although not one listed property company uses the structure due to the large conversion costs.
Crowe: I think the biggest region is right under our nose: Europe. Europe is woefully under-securitized. We can talk about the sexy, headline-grabbing markets of Brazil and China, but my forecast is that over the next five years, the European real estate securities market is going to be one of the most active.
You have a sophisticated financial market and a need for equity. You’ve already got an in-place base of successful real estate companies. They’ve already proved the concept, if you will. That’s where I think you’ll see a lot of activity.
REIT: Charles, what about in Asia?
Charles Wong: One market that has been in the news is the potential for Indian REITs. This is not without its challenges. Pricing will definitely be one of the key issues.
The health care sector in Japanese REITs is also something we expect in the near future. The rationale is compelling given the demographic trends, but, again, given the lease structures currently, pricing of the real estate will be most crucial for new listings to be successful in the long term.
REIT: European property markets have enjoyed a solid rally in the last three years. Do they have more room left to run?
Pine: The rally in the European property markets has been thus far supported more by capital inflows and cap rate compression than the strength in real estate operating fundamentals. Low interest rates and a commitment by the European Central Bank to loose monetary policy in 2014 have caused the European real estate market to continue to drift higher.
Any further significant upside has to be substantiated by corresponding positive developments in the underlying operating fundamentals. Even though there is some evidence of this in the U.K. and in select countries on the continent, we see higher risk-adjusted returns in regions outside of Europe.
Crowe: I still think they’re coming out of the bottom of the cycle. I think that valuations are relatively attractive compared to the U.S.
The challenge for us is always finding the right companies to invest with. In Europe, sometimes the companies behave like listed direct real estate funds as opposed to actively managed real estate businesses that are very effective in showing FFO growth. I think there’s going to be some further development of the European REIT market, and I think we’ve seen quite a lot of work done since the financial crisis. But there’s always that challenge of trying to get to the opportunities for the right entry point.
REIT: Asia, meanwhile, is still coming back to the pack, having underperformed the FTSE EPRA/NAREIT Global Real Estate Index for going on two years. Do you see this reversing any time soon?
Crowe: I think the worst is behind us in Asia, too. Asia has almost gone through a mid-cycle slowdown, if you will. They came out of the gate too hot, too fast following the global financial crisis. Part of the reason for that was they overestimated how important the U.S. and the West were to the underlying internal growth story with the growth of the middle class in places like China.
Buller: This is a difficult question to answer. Some of the largest discounted valuations can be found in Singapore and Hong Kong, although this phenomenon is probably with good reasons as the commercial and residential development fundamentals are relatively some of the weakest in the developed world. Also, these discounted valuations reflect some of the poor corporate governance in this region, and this has historically resulted in very bad capital allocation decisions.
Pine: It is unfair and inaccurate to paint all of Asia with one broad brush since each country’s stock performance has different political, macro and microeconomic drivers. Japan was the best performing country in 2013, and Emerging Asia has been enjoying particularly strong performance this year to date. Conversely, Hong Kong, China, and Singapore are undergoing residential property price corrections at the moment, as they digest the impact of easy liquidity on real estate as well as the expectations of rising interest rates.
However, slowing economic growth and policy risk are already reflected in the valuations of Hong Kong and China developers who are enjoying short-term periods of price reversal from time to time.
Wong: Not in the near term. As global growth is picking up in the U.S. and Europe, we believe cap rate compression in Asia is not being supported by earnings growth. Given the rise in leverage over recent years in most Asian economies, the moderation of credit might also reduce the rate of growth going forward.
However, we do see divergence within the region, particularly Japan and China. We believe they have more policy tools to better cope with any economic moderation.
REIT: One market that has seen a surge of new REITs is Mexico. How do you view the future of the Mexican fibras?
Pine: We view this increased level of activity in the Mexican stock exchange-listed real estate market as a positive development and believe in favorable capital markets and operating fundamentals supporting its further growth. We expect that relatively high yields, strong backing from sponsors and positive underlying supply and demand drivers will keep Mexican REITs on the radar for many global investors.
Not surprisingly though, in the short term, matters of external management and corporate governance generate a certain level of concern among global property investors. However, these are typical of a young REIT regime and will be addressed either though the evolution of legislation or under pressure from activist investors.
Cheigh: Obviously that has been an exciting place over the last 24 months. You’ve seen that it’s a good example where the REIT structure is able to attract capital. That capital has brought about value appreciation.
Increasingly, the fibra structure is going to become more of the dominant form of real estate ownership. Like any new space, I wouldn’t say it’s the Wild West, but as the stocks have done well, you’ve seen more coming out and going public than probably should be public. The market is going to need discipline.
Buller: The future of fibras is bright, although I agree that like any new REIT region, it will go through some growing pains. Currently, and likely in the future, there will be need to be adjustments in the external management structures and corporate governance.
India Joins the REIT Ranks
The Indian government in August approved the creation of real estate investment trusts in the country.
The rules issued by the Securities and Exchange Board of India closely hew to U.S. REITs. Notably, Indian REITs will be required to distribute at least 90 percent of net distributable cash flows to investors at least once every six months. At least 80 percent of the value of Indian REITs’ assets must come from properties that are generating revenue.
To be listed on a stock exchange, the assets owned or proposed to be owned by the REIT should be valued at a minimum of 5 billion rupees (approximately $80 million).
In anticipation of the announcement, U.S. private equity firm The Blackstone Group and Bangalore-based partner Embassy Group have already been preparing to launch India’s first REIT, a $2 billion office company. The size of the country’s real estate market is estimated to reach $180 billion by 2020.
REIT: Brazil hosted the World Cup this summer and is scheduled to host the 2016 Summer Olympics in Rio de Janeiro. Experts generally have mixed opinions about the economic impact for the hosts of these major events. On balance, do these have much of an effect – positive or negative – on your outlook for a market such as Brazil?
Cheigh: For events like that, not really. Certainly there is a decent-sized infrastructure build-up in many of these markets. They end up, in the grand scheme of the economy, being relatively small. Some would argue that it does often end up being a misallocation of capital.
Crowe: It’s more symbolic. It’s just one other sign of the fact that Brazil is a very interesting economy that has done a lot to make itself more worthy of institutional investment: the taming of inflation, the increased sophistication of the financial markets, as well as the transparency of the financial markets.
You don’t give a country the Olympics unless you think it’s capable of pulling it off. It takes a certain level of social, political and financial sophistication to make that happen. These are the ingredients you need to have a successful economy, financial market, real estate market and real estate securities market.
Pine: Undoubtedly, infrastructure development or increased levels of tourism contribute to a broader economic health of the country, but, more so, bring speculative short-term capital seeking quick gains.
REIT: Give us one major theme or trend in the global real estate markets that you are watching in the long term.
Wong: A couple of years ago, it was the China consumption story. More recently, it has been replaced with the growth in e-commerce within China.
However, there has always been one guiding principle I have used regarding all matters related to China, and that is saturation happens a lot quicker in China than a lot of other countries, especially today with more smartphone users and wider acceptance of social media.
One should beware of extrapolating excessive growth rates in their forecasts. If there is one good idea, there are 1.4 billion people ready to join you. When evaluating a business or opportunity, it then becomes important to assess whether there are sustainable advantages or how to operate in an extremely competitive environment.
Cheigh: Where we’re a little more cautious is the commercial market in China, particularly in the retail shopping center space. There’s a significant amount of new supply coming on. E-commerce is very much in the early innings.
We’re not bearish on China’s economy or the residential market, but I think that the news as it relates more to the commercial real estate market is probably going to get a little bit uglier for a while.
Pine: There is no doubt that rising interest rates will have an impact on global real estate markets. Back in 2009, many of us anticipated that rates in 2014 would be above current levels and have been since proven wrong.
Yet, interest rates will eventually rise. The question remains to what degree growth and inflation will be able to offset the effect of rising rates and prevent a revaluation of real assets.
Crowe: People are way too worried about interest rates. There is a large cap-rate spread between where interest rates are today and cap rates compared to history.
At the same time, I think we’ll really look back on this cycle and the biggest thing we’ve all missed while interest rates were going up is the very aggressive rental-growth cycle that we’re likely to get this cycle. That’s because of the complete lack of new construction. It’s going to take a lot of rental growth to get animal spirits excited enough to start funding new construction.
Buller: A trend we are watching with great interest is the larger percentage of development that REITs control in any given city compared with private developers. Real estate development is increasingly more complex in terms of permitting and construction, and especially in obtaining financing that you need from larger, more-respected players to get any project built. This trend is increasingly proving to be a competitive advantage for REITs compared to private players in the market.