|
|
Europe  Download PDF
March 31, 2008
We are pleased to share with you our review and outlook for the European real estate securities markets as of March 31, 2008. In the first quarter, the FTSE EPRA/NAREIT Europe Index had a total return of 6.5%, measured in U.S. dollars. In local currencies, the total return was 1.2%. By comparison, U.S. REITs, as measured by the FTSE NAREIT Equity REIT Index, had a total return of 1.4% for the quarter.
Investment Review
European real estate securities, down significantly in 2007, regained ground during the first quarter amid volatile global credit markets. Property stocks had been largely positive in January and February but retreated in early March before rallying as the month drew to a close. Companies with high leverage and expiring debt generally declined the most over investor concerns about their ability to secure financing. The near-failure of U.S. investment bank Bear Stearns did not directly affect European property stocks, but did signal that the global financial crisis is not yet over.
During the period, U.S. dollar investors benefited from the effect of favorable exchange rates in all countries except the United Kingdom, as most of the region’s currencies strengthened significantly against the dollar.
The U.K. cooled after a strong start
The United Kingdom (+1.2% total return) performed in line with the index. After posting one of their best months on record in January, property stocks sold off in late February when credit market volatility increased. A 25-basis point interest-rate cut by the Bank of England (BOE) in February, to 5.25%, failed to provide a sustained lift. Its mandate—like the European Central Bank, but unlike the U.S. Federal Reserve Bank—is solely to manage inflation, which at present is above target levels. As the pound has dropped against the euro (but not the dollar), the BOE has little room to maneuver without risking further inflation.
The U.K. economy remained strong, but concerns that financial sector layoffs will dampen demand for office space weighed on office REITs with holdings in the City; we believe that capital markets are starting to price that into the stocks.
Continental Europe had mixed performance
France (+6.0%) outperformed, boosted by shopping center stocks, which are considered safe havens. Dominant regional shopping center valuations have held up, debt levels are relatively low and their management teams are generally well-regarded. Office property stocks with central business district holdings, largely in Paris, also performed well during the quarter, benefiting from strong demand and a diverse tenant base.
Germany (–8.9%) underperformed the benchmark as two property stocks with company-specific issues dragged down returns. However, Alstria, an office REIT—and Germany’s only REIT—saw substantial gains. Its holdings are in attractive markets, the management team is strong and debt levels are relatively low. The company’s external growth opportunities, however, are limited, as REIT covenants place limits on its leverage.
The Netherlands (+2.7%) and Belgium (+4.3%) were strong performers, as investors were attracted to their defensive characteristics: minimal development, high occupancies, rising rents and conservative financing.
Norway (–33.8%) lagged, due primarily to the performance of Norwegian Property ASA. The company has above-average leverage and still needs to finalize its acquisition of Norgani, one of Europe’s largest hotel companies.
Stock selection aided performance
Our portfolios outperformed the benchmark during the quarter, led by our stock selection in the United Kingdom, France and Italy. The portfolios’ overweight position in France and the United Kingdom, and the lack of an allocation to Poland—one of the quarter’s poorer performing markets—also contributed to our outperformance.
Returns were hampered by our decision to not invest in Switzerland, our overweight in Italy and overweight in Norway. Stock selection in Germany also detracted from results.
Investment Outlook
Europe’s first-quarter outperformance may be threatened by credit and inflation concerns. If the U.K. economy slows, as expected, all property companies, including those with a focus on West End office buildings, are likely to experience declining values and rising capitalization rates. To date, the West End has been resilient due to a more diversified tenant base than the City; but it is unlikely that the two London neighborhoods would completely decouple during a prolonged economic slowdown.
Similarly, France faces economic headwinds, in which case, capitalization rates are likely to rise and spreads widen. A number of office buildings slated to come on the market in Paris’ La Défense business district beginning in 2011 may be delayed or cancelled if the credit crunch persists.
Germany’s economy is expected to slow on the back of the euro’s appreciation against the dollar. Although most of German GDP centers on exports to the rest of Europe, it will not be immune to the effect of declining European exports to the United States. If uneasy consumers retrench, Germany will likely experience an economic slowdown.
In this volatile credit environment, we expect investors will maintain their preference for conservatively financed property companies over those with high debt levels. Accordingly, property markets considered defensive and that provide attractive dividend yields are likely to receive the most investor attention—notably Netherlands, Belgium, Sweden and Finland.
* Country returns are in local currency as measured by the FTSE EPRA/NAREIT Europe Index
The views and opinions in the preceding commentary are as of the date of publication and are subject to change. This material represents an assessment of the market environment at a specific point in time, should not be relied upon as investment advice and is not intended to predict or depict performance of any investment.
|
|
|
