In January I highlighted the underperformance of the North America listed Real Estate Sector in 2017 but that it still didn’t offer great value – however with interest rates set to move higher in 2018 I looked forward to some interesting opportunities. Well, be careful what you wish for! By early February markets were in turmoil as US inflation finally reared its head, compounded by the Trump tax reform and a new Fed Chair who may, at least for now, have withdrawn the ‘Fed Put’.
Subsequently general equity markets have recovered, partly helped by volumes of self-fulfilling market commentary! The most appealing argument being that current technology revolution is radically improving productivity and will ease the pressure on employment markets and wages. The deflationary pressure of technological change has been with us for some time, but no one has any idea to what extent technology will help mitigate the next US inflation and interest rate cycle.
However the Global Real Estate sector has remained beached, with the Americas showing a total return of –10% ytd in Sterling. Bond yield are rising, and more importantly real yields are rising – the big question is whether the monetary authorities will deflate the QE bubble slowly or will be forced to act more quickly?
So am I buying into the US REIT sector on the correction? No. What has really come through on the Full Year results calls is how supply is picking up in US real estate markets. Public Storage warned two years ago about impending new supply in many regional self-storage markets, and during 2017 the office REITs started to discuss new office supply, particularly in Manhattan (eg the game-changing Hudson Yards regeneration). Now new supply is coming through in most markets, including Multi-Family residential, and credit to Equity Residential for highlighting the issue, while the mall sector continues to face the internet threat and on-going over-capacity. And so in the US, we face the threat of rising bond yields and rising supply/capacity. Ironically, Emerging markets have been the safe haven for the sector, showing a 2% TR ytd.
In Continental Europe, and in spite of very different QE, economic and real estate cycles, the listed Real Estate sector is down 5% ytd. The read across from the US has clearly been a factor, but we also have relatively high LTVs (>40% is common place), and new supply is starting to pick up, albeit from a very low base. Even in the UK (sector down 5% ytd), where LTVs have been steadily falling since 2009, we still have companies with LTVs of over 40% prepared to raise dividends rather than pay down debt. Even if the combination of Brexit and technology keeps UK GDP growth and inflation at modest levels, the risk of global bond yields and real yields rising further has increased. Thankfully there are few UK business locations where new supply is a threat, although the retail sector continues to face headwinds – the latest being the F&B sector (one of the few growth areas in recent years for the besieged mall operators) now starting to be squeezed.