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Global Real Estate Securities
As of December 31, 2009
We would like to share with you our review and outlook for the global real estate securities markets as of December 31, 2009. In the fourth quarter, the FTSE EPRA/NAREIT Developed Real Estate Index had a total return of +4.4% in U.S. dollars. For the year, the index had a total return of +38.2%.
INVESTMENT REVIEW
Global markets spent much of 2009 responding to the financial and credit market crises that began in 2008. After a challenging first two months, markets rallied, with momentum slowing in the fourth quarter. For the year, global real estate securities outperformed the broad equity markets: the FTSE EPRA/NAREIT Developed Real Estate Index had a total return of +38.2%, compared with +30.8% for the MSCI World Index.
Share prices began to rise in March when listed real estate companies demonstrated their access to multiple sources of capital. The recapitalization trend moved around the world—Australian listed property trusts, followed by U.K. REITs and then U.S. REITs. Cohen & Steers was instrumental in these capital raisings, and was a cornerstone investor in many of the offerings. Government monetary programs also had an enormous impact: they gave weak companies the time to renegotiate loans and repair their balance sheets while interest rates were at historic lows. This staved off the collapse of the real estate market, but it also deferred “fire sale” acquisition opportunities.
Recapitalization sparked the U.S. rally
U.S. REITs had a total return of +28.0% for the year as measured by the FTSE NAREIT Equity REIT Index. The group rebounded from multiyear lows after significant recapitalization and deleveraging reassured investors that they could strengthen their balance sheets, meet debt maturities and take advantage of buying opportunities. In total, public real estate companies raised $20 billion during the year.
Hotel companies were top performers
The hotel sector (+67.2%) led all U.S. property types in 2009. Their short leases allowed them to respond quickly to changing economic conditions, and they rose amid signs of economic stabilization and the possibility of future economic growth.
Regional malls (+63.0%) turned in a better-than-expected performance, benefiting from recapitalization and stabilization in retail sales and consumer confidence. Simon Property Group, the country’s largest mall operator, was the first major U.S. REIT to issue new equity. Office REITs (+35.6%) were aided by less-severe unemployment in New York than anticipated.
Shopping centers declined
The shopping center sector (–1.7%) was the only REIT property group to post a negative total return during the year. Typically considered defensive because of their consumer staple anchors (supermarkets and drug stores), the smaller retailers that make up the rest of the tenant mix proved to be highly sensitive to the economic downturn.
Health care REITs (+24.6%) and self storage companies (+8.4%) trailed the benchmark, as defensive sectors lagged their more economically sensitive counterparts during 2009’s rally.
U.K. cap rates declined
The United Kingdom (which had a total return of +16.5% in the year) 1 advanced in the second quarter, aided by the capital raisings that began in February. However, the rally leveled off in June, once major REITs’ capital needs had been met and investors refocused on fundamentals, which remained weak. Third- and fourth-quarter property transactions indicated that valuations of high-quality commercial real estate had stabilized, and cap rates declined considerably.
France paced Europe’s rally
France (+50.0%) had the strongest performance of Europe’s major economies. For many years rents were indexed to the cost of construction, which benefited office and retail properties. Indexation turned negative in the second half of the year, however, which has put downward pressure on rents.
Over the course of the year Germany (+19.7%), Europe’s largest economy, dropped sharply and then reversed course, aided by government stimulus spending and construction investment. As of September (the latest data available), industrial orders had risen for seven consecutive months.
In news, Spain (which is not included in the index) launched its version of the REIT model (SOCIMI) in June. Unlike most REIT structures, it includes a corporate income tax (18%); however, dividends paid to individuals will be tax-exempt.
Asia Pacific outperformed the U.S. and Europe
Hong Kong property stocks (+88.8%) benefited from flows from China, declining lending rates, and limited residential supply, along with a brightening economic outlook. Shares of developers had sizable gains, notwithstanding concerns about the sustainability of the rise in residential prices. Landlords advanced, aided by signs that office rents had seen the worst of their declines.
Japan (+4.1%) began to rebound after a weak start. In the first half of the year, financially weaker J-REITs, which had declined on bankruptcy worries, saw a sharp turnaround in performance amid indications that the government was willing to support the group.
Australia (+6.4%) strengthened in the wake of recapitalizations, and benefited further as the country’s economy turned a positive corner sooner than expected. In the fourth quarter, in response to economic growth, the country’s central bank reversed its monetary easing policy and increased short-term interest rates to 3.75%.
Singapore (+78.4%) saw brightening economic prospects as well as a rebound in residential transaction volume, aided by developers’ price cuts and new mortgage offerings from local banks. The market’s office stocks performed well despite supply concerns and a continued decline in rents; demand held up better than expected, with resilient lease renewal.
Portfolio performance
Our portfolios had sizable absolute returns for the year and performed approximately in line with their benchmarks. The main positive contributors to performance were our underweight and stock selection in the United States and stock selection and overweight in Hong Kong. We had a modest allocation to Brazil (which is not included in the index), which had a strong gain in the period. Our underweight in Switzerland (which had a total return of +18.9% within the index) and allocation to Norway also aided performance.
Factors that detracted from relative performance included stock selection in Japan; we were underweight certain J-REITs that we viewed as less attractive, but which benefited from the government’s decision to provide refinancing. Our overweight and stock selection in the United Kingdom and underweight in France also hindered performance, as did stock selection in Germany.
INVESTMENT OUTLOOK
We expect 2010 to be a year of moderate economic growth and continued stabilization in global capital markets. The deleveraging in real estate markets that began in 2009 will likely continue, which could put some constraints on growth. Further capital raising will most likely be for acquisitions. In this environment of low interest rates and relatively high cap rates, well-capitalized REITs may have acquisition opportunities that will be immediately accretive to funds from operations and net asset values. We believe this is the beginning of the acquisition and fundamental recovery phases of the total return cycle.
At present there is virtually no new construction in most markets, which speaks to the potential for better-than-expected net operating income in 2010 and 2011. Acquisitions, rent growth and organic growth offer the possibility for earnings to accelerate, which will be particularly important if central banks raise interest rates. Private companies in need of capital may decide to go public and launch a new IPO cycle.
U.S. acquisition cycle is under way
In the United States, non-bank real estate financing is poised to resume, which could drive further cap rate compression. We expect lender workouts and capital markets to normalize mid-2010, at which time there should be a high volume of accretive acquisition opportunities.
On a sector-specific basis, we believe that shopping centers and class-A malls will perform well. Offices should benefit from low supply and stabilization in jobs, and industrial REITs from a bottoming in gross domestic product and the start of the inventory cycle. While we find apartment company fundamentals attractive, we remain cautious because of their less favorable valuations.
European outlook is positive
We expect to see a reasonable recovery in the United Kingdom due to massive policy stimulus, a weak currency and improving credit. There has been significant cap-rate compression across prime assets already, and the trend should continue. This reflects London offices’ ties to a global economy, demand for high-quality properties from foreign investors and a relatively benign supply backdrop. While a modest increase in supply is projected for 2010—mostly in the City—the development pipeline in London stands at a 20-year low. We believe rents in West End and City offices will rise substantially over 2010 on the back of this low availability. The outlook for the retail rents is more subdued as U.K. consumer growth remains sluggish.
France’s somewhat insulated economy and strong consumers gave it some downside protection in the recession, yet early indicators suggest that its participation in the recovery is better than expected. The rental declines for prime Paris office space have moderated, easing concerns about a dramatic downturn. We believe that fundamentals point to long-term growth. Retailers, meanwhile, should continue to see relatively resilient income streams, although the contribution to rents from indexation is fading (more so for office companies).
Although the Netherlands lacks country-specific catalysts, it is home to attractive pan-European mall owners with strong balance sheets; we favor those with visible cash flows and good management teams. Germany’s rebound indicates that it could have the best economic backdrop within Europe in 2010, which would give some aid to currently weak real estate fundamentals. High leverage among listed real estate companies remains a concern.
Japan faces challenges but offers value
In Japan our focus remains on property companies with good balance sheets. We are cautious toward J-REITs, favoring those with strong sponsors. Over time, J-REITs should be able to expand their portfolios, earning more favor from their ability to make acquisitions amid scarce capital. Still, given falling rents and rising vacancies, dividend growth will be difficult to achieve.
Hong Kong’s economy is gradually recovering. In the office sector, property values have already shown signs of a rebound, while the decline in rents has moderated significantly. We believe a bottom is near and that significant rental growth could occur in 2010 and especially 2011. Residential prices stand to benefit over time from economic recovery and the availability of fixed-rate mortgage plans.
Australia’s unemployment rate fell slightly in November, and the majority of job growth was full time. We remain positive on the country’s relative economic strength and view its office sector as the largest beneficiary. Stock valuations are attractive, in our view.
In Singapore, we are turning more positive on sectors driven by a recovery in external demand, including offices and hotels. After the strong rally in the residential sector in 2009, the government is imposing tightening measures on the mass market; we favor developers with a higher luxury component, which should be less affected by policy measures.
1 Country returns are in local currency as measured by the FTSE EPRA/NAREIT Developed Real Estate Index.
Past performance is no guarantee of future results.
The views and opinions in the preceding commentary are as of the date of publication and are subject to change. This material should not be relied upon as investment advice, does not constitute a recommendation to buy or sell a security or other investment and is not intended to predict or depict performance of any investment.
Please consider the investment objectives, risks, charges and expenses of
any Cohen & Steers fund carefully before investing. A prospectus containing
this and other information can be viewed by
here
or may be obtained by calling 800-330-7348. Please read the prospectus
carefully before investing. Cohen & Steers open-end funds are distributed by
Cohen & Steers Securities, LLC.
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