Guy Barnard and Tim Gibson, Co-Heads of the Global Property Equities Team, provide a mid-year review of the market and outlook for the rest of the year, as well as share the sectors that garner their favour.
How have real estate markets fared so far in 2018, and how has this impacted your portfolio positioning?
Global property equities have faced the dual headwinds of rising interest rates as global growth expectations accelerate, as well as ongoing challenges in the retail sector, given the growth of ecommerce. This backdrop has not come as a surprise to us. It simply reinforces our belief in the importance of being selective and active real estate managers.
Technological change, rapid urbanisation and shifts in demographics are fundamentally altering consumer behaviours and redefining the needs and uses for real estate. This has led us to be increasingly discerning in our holdings and focused on those cities, sectors and companies where we see the potential for sustained revenue growth, while avoiding companies lacking growth (the so-called ‘bond proxies’ that are perceived to pay safe and predictable income with less volatile prices), where asset values may be eroded by rising interest rates, declining occupancy or falling rents.
To date this has worked well, with companies exposed to sectors such as logistics, data centres and affordable housing generally outperforming more traditional real estate sectors, such as retail. Diversification away from the US into markets in the higher growth phase of the real estate cycle, such as Singapore, Hong Kong, Germany and Spain, has also been beneficial.
Has your outlook for the remainder of the year changed?
Twelve months ago we felt that real estate equities looked attractive relative to bonds, but less compelling against the wider equity market where earnings growth was accelerating.
Today, we continue to believe that the dividend yield for real estate investment trusts (REITs) looks attractive relative to interest rates, and compared to the yield from government and corporate bonds. Particularly in light of our expectations for continued dividend growth from REITs in the years ahead. In addition, the dividend yield (dividends paid relative to market value per share) now looks increasingly compelling, most notably in the US where REITs currently offer a dividend yield of approximately 4.4% versus the average yield of 1.9% from companies listed on the S&P 500 Index. (Source Thomson Reuters Datastream FTSE NAREIT US Real Estate Index, S&P 500 Index as at 25 May 2018. Dividend yields may vary and are not guaranteed. Past performance is not a guide to future performance).
Valuations for the real estate sector are also trading close to historical lows against the wider equity market. We see this as attractive value, especially when we look into 2019 as the broader market’s one-time benefit from US tax reform will have passed, and earnings growth could moderate dramatically. In contrast, we expect our favoured REITs can deliver 2019 growth at levels broadly consistent with our expectations for 2018. (Team forecast may vary and is not guaranteed).
This relative valuation opportunity combined with our ongoing view that a number of longer-term trends remain (the 3Ds: demographics, tech disruption and debt reduction) should keep interest rates relatively low going forward. Therefore, we would not be surprised to see global REITs outperforming the wider equity market in the second half of 2018.
Clearly, if we are wrong about the extent to which bond yields rise from here then this will likely put further pressure on the real estate sector. However, investor positioning today appears to reflect some of this risk.
Which sectors or themes are presenting the most attractive opportunities?
Our fundamental belief is that identifying long-term growth within real estate markets is key. This is particularly significant in an environment where we are seeing a reversal in monetary policy, while many countries and sectors are moving later into the real estate cycle, characterised by heightened supply and rising vacancies.
As a result, we have a less favourable view on retail landlords, focused only on differentiated ‘best in class’ operators who are actively adapting in order to emerge as winners. Logistics enjoys one the most positive fundamental backdrops among the traditional real estate sectors – how many parcels arrived in your household last Christmas? We gain exposure to this trend through global logistics owners and developers who are the landlords of choice for Amazon and other e-tailers.
We also invest in global data centres and cell tower companies, where we expect growth trends to remain highly favourable. Finally, we see further upside in companies offering affordable and flexible housing in growing markets such as Germany, the Philippines and burgeoning US cities.
We therefore remain excited about the prospects for our focused portfolios, which we believe are well positioned to benefit from these evolving trends.