Tim Gibson, Director and Co-Portfolio Manager for Global Property Equities, is keeping a close eye on U.S. interest rates. He also notes that disruption, while presenting risks, is unearthing opportunities for property equities investors.

Will global property equities continue to underperform?

Even though equity and bond markets began to consider the possibility of interest rate rises in the U.S. in May 2013, it took another two and half years before we saw rates actually rise in December 2015. Since then, we have had eight interest rate rises in total, with the futures markets pricing in several more.

Markets, by their nature, are forward looking, reacting to news that is better or worse than relative expectations. The recent Q3 2018 results in the U.S. saw cracks beginning to appear in corporate America as industrial companies, including heavy machinery as well as technology companies, delivered weaker-than-expected results. This was caused, in part, by rising input prices as the impact from higher wages, interest costs and trade tariffs began to bite.

This opens the door to the possibility that U.S. equity market earnings growth may be peaking, with the prospect of downgrades to come.

If earnings growth is slowing, then a key question for 2019 would be: Has the interest rate cycle in the U.S. peaked? If the answer is yes, then this would be very positive for REITs, as investors focus on companies with good earnings and dividend transparency. In addition to this, we still forecast continued earnings growth, with well-covered dividends for REITs.

What challenges do we face within our sector?

Rising interest rates haven’t been the only challenge for the sector. Structural changes have been happening in retail, leading to winners and losers. Indeed, the range of earnings growth within the real estate sectors has, in our view, never been wider. As real estate investors who believe in being active managers, this excites us.

Technological change, rapid urbanization and shifts in demographics are fundamentally altering consumer behaviors and redefining the needs and uses for real estate. The rise of e-commerce has changed the face of retail, and epitaphs have long been written about the death of shopping malls.

However, the growth of e-commerce has fueled demand for modern logistics space as traditional warehouse “sheds” have turned into new shops of the world. E-commerce can require as much as three times more logistics space than traditional brick-and-mortar retailers, and strategically located logistics assets are becoming more important in order to fulfill ever-increasing expectations of the speed of online delivery. The record set in San Francisco was eight minutes, from click to delivery!

What opportunities exist, and how are we positioned for these?

These trends are always gradual and rarely happen overnight, but we are very selective in our holdings of retail landlords in recent years, focusing only on best-in-class operators that we believe have embraced this structural shift and have actively adapted in order to emerge as winners.

On the other hand, we have increased our positions in global logistics developers that are at the forefront of the development of modern logistics.

We also have positions in a number of data centers and tower companies where we expect secular growth trends to remain highly favorable for the foreseeable future.

Finally, on a country level, we see further upside in companies offering affordable and flexible housing in growing markets such as Germany, the Philippines and burgeoning cities within the U.S.

Where could we be wrong?

Clearly, if the long end of the yield curve rises faster than expected, possibly due to better economic data, this would put further downward pressure on the sector. Alternatively, if the yield curve were to invert, implying an impending economic correction, then this would negatively impact share price performance.