A roundtable with global real estate fund managers looks at rising interest rates and Europe.
9/9/2015 | By Dawn Wotapka
REIT magazine: September/October 2015
The global real estate markets might have been choppy a few years ago, but investors say 2015 has been smooth sailing. Experts say interest rate concerns, which continue to weigh on the sector, remain overblown and real estate remains a sound investment. Meanwhile, sector watchers are optimistic, given the major news stories - Greece and China - involve nations that don’t overtly and dramatically spill into REIT performance.
Through the first seven months of the year, the FTSE EPRA/NAREIT Global Real Estate Index produced total returns of about 0.5 percent, down from nearly 15 percent for all of 2014.
The Asia-Pacific and Europe regions are roughly level with last year, while the Americas and Middle East-Africa are down from 2014.
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
- Jay Leupp, Managing Director, Lazard Asset Management
- Al Otero, Managing Director, Global Portfolio Manager, EII Capital Management, Inc.
- Christopher S. Reich, Principal, Senior Global Portfolio Manager, CBRE Clarion Securities
- Sherri Schugart, Senior Managing Director/CEO – Hines’ REIT Group, Hines
REIT: What’s the top theme or trend in the global real estate markets that you are watching in the long term?
Christopher Reich: Many of the world’s private commercial real estate markets could be considered under-securitized, particularly in the newer REIT markets in Europe and a number of emerging markets. We expect a continued transition of real estate into the listed arena in the coming decades as listed real estate becomes an increasingly accepted asset class and owners and investors recognize the benefits of listed real estate.
Jay Leupp: We break this into three parts: real estate supply, real estate demand and interest rates/capital markets. For the most part, supply kept pace with demand in major sectors. We still are undersupplied in key parts of the world…and demand has been really coincident with a slowly recovering economy. We continue to monitor that.
One of the major risks in our space is oversupply, building out ahead of demand, which causes rents to fall and property values to drop. We have not seen that yet in the U.S.
We expect interest rates to rise over time. In the near term we still view the interest rate environment as quite favorable to real estate.
Al Otero: Urbanization/densification is a wonderful trend that is playing out in cities and countries across the globe, and listed property companies are uniquely positioned to contribute to and benefit from this phenomenon.
We live in an exciting time where young, educated and entrepreneurial people want to “live/work/play” in vibrant, socially integrated cities where the physical and technological infrastructure drastically improves the quality of their lives. Major cities such as London, Hong Kong, Beijing and Toronto are collaborating with public companies and private capital to undertake large-scale, complicated mixed-use projects that are expected to attract both domestic and foreign users alike to areas that were either underutilized, obsolete or inefficient.
REIT: What are the best things global REITs have going today?
Reich: The current property cycle is likely to be the longest in decades. Global economic growth is improving, but at a slower pace than in past recoveries. This has the dual benefit of generating a gradual improvement in demand for real estate space, while allowing for a relatively low inflation, low interest rate environment to persist, which should provide for continued demand for the asset class.
Also, unlike prior cycles, real estate development has not ramped up in a meaningful way, so as demand picks up, it will not necessarily be met with increasing supply thereby putting gradual, upward pressure on rental growth.
Finally, given the above, M&A is picking up, particularly since listed real estate companies trade at a discount to estimated private market values.
Otero: Global real estate companies of today have the size, scale, expertise and access to capital to compete and take market share in a highly competitive global marketplace. Over recent years, public real estate companies have invested heavily in the systems and technology that make them extremely efficient in areas such as asset management, accounting, construction/development and capital markets. These advancements make for logical partnerships with highly sought-after municipalities, tenants and various other constituents.
Sherri Schugart: Global REITs have the flexibility to invest more broadly across the world where it makes sense and where there is relative value that drives favorable investment performance. A narrowly defined REIT may be beholden to one particular investment theme, [and] by the time the money is raised and placed, it’s no longer at an attractive place in the cycle. Additionally, investing in multiple countries and markets provides more diversification, which may help reduce volatility given the varied correlation amongst global economies and markets.
REIT: On the flip side, what is the biggest issue facing the industry?
Steve Buller: The perception, and I emphasize the word perception, that rising interest rates can be a negative for the return of global real estate securities. If you look through many studies, you know there isn’t necessarily a direct correlation between higher interest rates and negative performance of global real estate securities.
Otero: The potential longer-term impact that cheap capital has had on the asset class.
Years of easy money policies on the parts of governments across the globe have materially inflated valuations for most risk assets, including commercial real estate. This flood of inexpensive capital has caused capitalization rates to compress beyond levels that may be sustainable once global interest rates begin to normalize.
Schugart: The public non-listed REIT industry is currently facing some fairly significant regulations in early 2016, which [will] include new disclosures and better transparency for investors. We believe this will have a positive impact for investors and the industry in the long term, but it is clearly causing decreased access to capital in the near term until that part of the industry has adapted to these new regulations through changes to product structures, fees and certain operational issues.
REIT: Are there any particular regions or sectors around the globe that don’t have REITs but could be particularly well-suited to listed real estate investment? Or perhaps an existing REIT regime in need of an overhaul?
Reich: There are several commercial real estate markets around the world that could be considered under-securitized, namely parts of Europe and emerging markets, such as China and India. While most of the markets in Europe now have a REIT structure, we continue to believe that there is ample opportunity for those markets to continue to grow as more and more real estate is securitized.
The other observation has been that when REIT structures are introduced without attractive tax structures, it is difficult for those REIT markets to gain any traction. We have seen this occur in both the Philippines and in India, two markets which will require an overhaul in order to be successful. China has begun to dabble in a variety of “pilot” programs and there is certainly great potential over the long term given the size of its economy, but it is early days.
REIT: Are there any markets that you are avoiding?
Reich: We generally take a cautious approach to investing in companies focused on emerging markets, given inferior transparency and corporate governance relative to companies in developed markets. In addition, almost by definition, real estate companies in emerging markets tend to focus on development activities, which is inherently a riskier business model than owning and operating commercial real estate.
Our return requirements for investing in emerging markets [are] much higher than those for developed markets. At the moment, we have very limited exposure to emerging markets as we see ample opportunity in developed markets, but with lower risk.
REIT: Let’s dive into performance. In the past five years, Europe and Middle East-Africa are neck and neck when it comes to total returns. Which one has the best outlook?
Leupp: Longer term, Europe probably has the potential for higher returns if we can see acceleration in growth rates. It has a large pool of high-quality institutional assets that are owned in the public market for which there has historically been long-term investor demand.
REIT: When comparing some more recent metrics, Europe and the Americas are nearly identical. Who could emerge the winner, and why? What issues do each face?
Buller: I very much like the U.K. because they have some of the best performing real estate fundamentals, driven primarily by what’s going on in London. At the same time, they benefit from a cost of capital advantage and they’re at a reasonable price.
Reich: We see good opportunities in both markets. At the start of the year, it would have been easier to prefer Europe over the U.S., given relative valuations as well as the expectation for divergent Central Bank policies. That said, given the year-to-date underperformance of the U.S., it is now a tougher call. As such, it comes down to one’s time horizon.
In the shorter term, European property stocks probably have the advantage given an expectation for continued ultra-loose monetary policy, while the Fed is likely to hike rates in the U.S. Over the longer term, the U.S. REIT market probably outperforms Europe given better growth on the back of a more sound economy.
Schugart: Determining which of these emerges as a “winner” depends on several things, including your particular investment strategy, investment horizon, and individual markets and submarkets within Europe and the Americas, as there is great diversion within these broader regions at the market and submarket level.
In Europe, Germany and the U.K. are currently quite expensive, as are certain key coastal markets in the U.S., which again may provide great opportunities for investors seeking very high-quality core assets with long-term investment horizons. Alternatively, there are many countries in peripheral Europe and many secondary markets in the U.S. that have further longevity remaining in their cycle and may provide great investing opportunities for investors with shorter time horizons.
Dawn Wotapka is a former real estate writer for The Wall Street Journal.
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