June 7, 2018
Keillen Ndlovu, STANLIB Head of Listed Property
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Rising US 10-year bond yields and a higher interest rate saw global listed property lose 6% in US dollars in the first quarter of 2018. With the Federal Reserve expected to hike rates at least three more times this year, what will this mean for the global property market? Is the cycle nearing its end or is there still value to be found?
Global investment in real estate reached a record high of US$1.62 trillion in 2017 with Asian money accounting for more than half of all capital spent. Last year’s record volume of real estate traded and prices achieved will be difficult to maintain but we believe there is little reason to fear any sudden reversal in 2018.
Global property analysis by sector shows that online shopping continues to grow at the expense of physical retail. Mall real estate investment trusts (REITs) are trading at discounts to net asset value of over 25%, which has triggered a flurry of corporate activity.
The hottest sector in listed property is industrial- and logistics-focused REITs. Ecommerce sales are expected to grow from approximately $2 trillion worldwide in 2017 to nearly $3.5 trillion by 2020. This is hugely significant for logistics REITs because ecommerce fulfilment requires roughly three times the floor space of brick-and-mortar retailers. At present, only about 12% of all retail sales are online. As this percentage increases, so will the need for logistics real estate.
Another trend making the headlines is the growth in co-working and flexible office work space. Research by global property consultants JLL shows that co-working space has absorbed more than 18 million square feet of office space in the US since 2015 – almost a third of the total growth in usage during that time.
While listed property is experiencing a bumpy start to the year, we see this as a correction rather than the end of the cycle. Property fundamentals remain in good shape and are backed by positive global economic growth prospects.
According to our analysis, global listed property is trading at a discount to net asset value of about 8% and is offering a one-year forward yield of 4.8%, assuming 5% earnings growth. It is possible that the market will grow even faster than expected, with plenty of corporate activity in the retail property space and a decent gap between property and bond yields. In particular,we believe the following three companies are offering investors strong opportunities for growth.
Prologis is the largest industrial REIT in the US with a $35 billion market capitalisation, providing industrial warehouse space in some of the world’s busiest distribution markets. Its properties are typically located in large infill markets (real estate markets where the majority of properties are built in urban centres, where space is scarce and new developments often involve rebuilding higher buildings over older lots) with nearby airports, seaports and ground transportation facilities enabling rapid product distribution. Most products sold online will pass through a Prologis-owned property at some stage because it is the world’s leading owner, operator and developer of logistics real estate.
The company forecasts 162% growth in ecommerce sales from 2015 to 2020. While it’s not cheap on valuation, Prologis is excellently placed to benefit from the ever-expanding ecommerce sector and positive world GDP growth.
Simon Property Group (SPG) is the biggest real estate investment trust and largest shopping mall owner in the US. Like all retail REITs, it has been grappling with the rise in online shopping and the fall in demand for retail space. Yet unlike some of its rivals, SPG has been making concerted efforts to overhaul its properties and adopt omni-channel strategies to make its malls more alluring.
Over the past five years, SPG has invested more than $5 billion in development and redevelopment projects and intends to invest $1 billion more in 2018. In our view, SPG is one of the best mall operators in the US and better positioned for ecommerce than its competitors.
Unibail-Rodamco, Europe’s largest mall landlord, has launched a takeover bid for Westfield Plc, the Australian-based global mall REIT. If the transaction goes ahead, Unibail-Rodamco will become the largest listed mall REIT in the world. Despite concerns over retail, this deal shows that well-positioned properties with a good tenant mix in strong catchment areas continue to be desirable.
The French real estate giant is well prepared for ecommerce growth. We believe Unibail- Rodamco’s current valuation is reasonable given its good short- and long-term outlook. The company is extremely well managed, it owns some of the highest quality commercial real estate in Europe and its EUR8.1 billion development pipeline is significant.
Even with a positive outlook for global property, it’s important not to overlook the downside risk. Higher than expected bond yields and interest rate hikes could impact global property yields, as could lower than expected economic growth. There are worries about London in the run-up to Brexit, with property markets showing lower rental growth.
Although some large economies are already starting to increase interest rates, the spread between real estate yields and fixed income remains above the long-term average. This should continue to entice investors despite the competitive pricing environment.