Q, Why is now the right time to invest in real estate
through the public rather than private markets? Are there issues
of liquidity and return to take on board?
Currently, listed real estate prices offer due to the stability and long-term nature of their lease-based cash flows but now these are trading at a discount.
The spread between REIT implied cap rates: the property net operating income divided by their Enterprise Value, and corporate bonds is about double the historical average (150 to 200 bps compared with 75 bps). REIT dividend yields is about 300 bps spread over government bonds!
Many REITs trade at a discount to the value of their properties in the private market, creating a quasi-arbitrage opportunity. This is because listed real estate is liquid and it tends to reprice faster than private real estate in downturns. REIT prices are implying valuations for their portfolios which are 10 per cent to 20 per cent below the value of their portfolios if sold in the private market.
Historically, private real estate markets have followed listed real estate markets with a “lag”. This creates an arbitrage opportunity. Listed real estate has historically outperformed private real estate when at a NAV discount and private real estate has historically suffered after listed real estate trades at a discount.
We think REITs are primed to perform in a vaccine-driven recovery and at this point in the economic cycle. This is supported by past data where US REITs outperformed US private real estate by c. 20 per cent per annum and US equities by about 11 per cent per annum in early cycle recovery periods between 1991 and 2019.
On liquidity, listed real estate equities and REITs are far more liquid than private real estate as it can be readily traded on the stock exchange. On the other hand, private real estate typically takes months or even more than one year from marketing, due diligence, exchange of contracts to the completion of the transaction depending on the market condition and the characteristics of the real estate.
Q, Where are the most attractive opportunities in listed
real estate now and for the next year or so?
Due to fears around the impact of the COVID-19 pandemic on dense urban environments, real estate in global cities is available in the listed market at a large discount to private market values. We see investing in REITs focused on the world’s leading “global cities” as one of the most attractive opportunities today.
The current discount between REIT prices and the value of their underlying real estate is historically wide. Historically, these REITs trade at or above their private market values but now at a 10 per cent to 20 per cent discount. Lower pricing also results in attractive yields which are at 75 to 125 bps higher than private real estate and a whopping 500 bps higher than the US 10-year treasury rate.
We are a strong believer that urbanisation is an ongoing process and COVID-19 is not going to change this. Urbanisation is a decades-long megatrend that continues to shape the global economy – 55 per cent of the world’s population already lives in urban areas and that’s expected to rise to 68 per cent by 2050.
We would like to think that listed real estate is a niche in the public equity markets and working with specialists will be the key to outperformance over time. The global market capitalisation of listed real estate is about $2.1 trillion – that’s about the size of Apple and Tesla combined – and REITs are about 3 per cent of the S&P 500. As a result, generalist equity managers do not do in-depth work on real estate – it just does not make sense for them to spend the time to do so. Investors would want to work with firms that have real estate expertise as a core competency. This specialist managers can understand the nuances of real estate markets such as why do you want to own in some parts of a city and not others, make physical property visits and meet with management teams.
Our background is in private real estate so to develop a strategy in this space, we’ve chosen to work with CenterSquare Investment Management, who are one of the leading investors in listed real estate. CenterSquare has a 25-year track record of outperformance in listed real estate with an experienced global team focused exclusively on real estate securities, who have worked together for decades. Combined, we like to think that we offer: global perspective, deep real estate market knowledge, and a strong track record.
It is worth noting as well that in listed real estate, active management has historically outperformed passive strategies. According to data from eVestment Alliance, over a 10-year time-frame 76 per cent of listed real estate managers outperform their benchmark compared with 68 per cent for fixed income and 44 per cent for large-cap equity. A key factor in this is understanding the underlying real estate trends and dynamics.
Q, How in your view has the Covid crisis affected real
estate and what opportunities has it created?
One of the results of the COVID-19 pandemic and economic downturn is that interest rates are remaining lower for even longer. Low interest rates have increased the pricing of assets, lowered expected returns and as a result, investors have been gravitating to more risky investment strategies to get their returns. Bond yields are near record lows and provide very little income return – as a result, there has been a rotation out of fixed income towards higher returning but more risky investments.
Technology and growth stock valuations have skyrocketed as investors have been more happy to pay-up for growth and hopefully profitability down the line. There’s been a boom in SPACs (special purpose acquisition companies) targeting hot sectors including fintech, electric vehicles and software as a service (SaaS) businesses and bitcoin has been on a tear – but extremely volatile!
We need to ask ourselves whether these investment strategies are sustainable? Or are we in a bubble? We are not smart enough to figure that out and fortunately, we see an attractive opportunity set in our speciality – commercial real estate.
In this environment, commercial real estate offers attractive and stable income returns, which are significantly higher than fixed income yields, while offering potential upside from capital appreciation as the impact of COVID-19 recedes along with other benefits. Historically, real estate has generated stable low double digit total returns with the majority of the return through income. Commercial real estate is also a good protection against inflation as rents have typically grown in line with inflation, providing a partial inflation hedge. Adding to that, real estate can also provide diversification benefits in a portfolio as it has relatively low correlations with fixed income and equity returns.