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Global Real Estate Securities
As of May 31, 2009
We would like to share with you our review and outlook for the global real estate securities markets as of May 31, 2009. For the month, the FTSE EPRA/NAREIT Developed Real Estate Index had a total return of +12.6% in U.S. dollars. Year to date, the index had a total return of +5.9%.
INVESTMENT REVIEW
Global real estate securities extended their strong recovery into May although not quite at April’s blistering pace. Most markets had gains amid a sense that the worst of the financial crisis may be behind us. Asia Pacific was the top-performing region, outdistancing North America and Europe by wide margins.
U.S. REITs, with a total return of 2.2% as measured by the FTSE NAREIT Equity REIT Index, paused in May following April’s 31% return. The stream of recapitalizations continued; in May alone, 16 companies raised close to $5.5 billion in debt and equity, and the cost of capital continued to decline. Recent activity was undertaken with an eye toward distressed acquisition opportunities.
Most U.S. sectors rose
Hotel REITs (+17.7%) led all U.S. property types again this month, although their fundamentals remained challenging. Cyclical hotel company shares respond quickly to economic changes, and they outperformed in May amid signs that the economy may be bottoming. The apartment sector (+7.1%) was propelled by continued availability of inexpensive debt through Fannie Mae and Freddie Mac, coupled with access to the equity markets (Camden Property Trust raised $275 million). Regional mall companies (+2.8%) were led by Simon Property Group, which raised an additional $1.7 billion in debt and equity; it is expected to use the proceeds to make opportunistic acquisitions.
Canada (+10.5%) was a top performer as the country’s five largest banks have healthy balance sheets and continued to provide debt financing. Also, REITs’ first-quarter results, driven by commodity-sensitive western Canada, exceeded expectations.
U.K. property securities cooled
The United Kingdom (–4.5%) declined after a strong showing in April in response to successful capital raisings by major U.K. REITs. However, leading companies reported disappointing news regarding vacancies and rents, cooling investors’ enthusiasm. Although equity rights issuance subsided in May (most U.K. REITs have already recapitalized), Great Portland Estates and Shaftesbury, companies with significant holdings in London’s West End, raised a combined £315 million to acquire properties at compelling values.
In France (+4.5%), Foncière des Régions continued to rebound after being punished by leverage concerns earlier in the year. The company delivered on its asset sales program and reported strong rental growth. Gecina rallied on news of changes in senior management that should promote better corporate governance. Unibail-Rodamco, which accounts for about half of France’s weighting in the index, had a flat return but remained ahead of the index for the year-to-date period. Germany (+3.1%), which reported worse-than-expected first-quarter GDP, advanced as more recent evidence (including an increase in industrial orders) suggested that its economy may be at or near a trough.
Hong Kong and Singapore led Asia Pacific
Hong Kong’s performance (+27.8%) was driven by strong liquidity and improving market sentiment. Among non-REIT property companies, developers had significant gains; very low interest rates on both savings deposits and mortgages have facilitated residential purchases. Landlords also performed well, despite a downward trend in rents. With respect to the market’s REITs, Champion surged on evidence of an uptrend in office transactions in the central business district.
In Japan (+18.9%), J-REITs had gains but significantly underperformed developers. The Land Ministry released a white paper calling for the consolidation of Japanese REITs, but this failed to lift the group. While fundamentals in the office market remained weak, the condominium market showed a slight improvement for the second consecutive month, after months of deterioration.
Australia’s performance (+3.3%) was mixed. GPT Group benefited from its announced A$1.7 billion equity offering, which makes it one of the country’s least-leveraged listed property trusts. Goodman Group, on the other hand, dropped sharply on the perception that its recent deal to secure A$300 million in financing would not materially improve its balance sheet.
Singapore’s (+34.4%) solid performance was led by smaller developers; returns for S-REITs were also strong. The resurgence occurred despite retail sales falling for the sixth consecutive month in March (the most recent data), while exports continued their decline.
Portfolio performance
Our portfolios performed in line with their benchmarks. Stock selection in Asia Pacific and continental Europe were positive contributors to relative return, as was our underweight in North America. In specific markets, our overweight in Hong Kong and stock selection in Singapore contributed to relative performance. The benefit of our underweight positions in the United States and Australia were more than offset by stock selection in those markets. Detractors from performance also included our underweight in Japan, which eclipsed the positive effect of our stock selection, and our overweight and stock selection in the United Kingdom.
U.S. dollar-based investors benefited from movements in exchange rates. Returns in European markets were significantly higher when translated into dollars, as the euro, British pound and other European currencies rose in value against the dollar. Asia Pacific returns were modestly higher, as the region’s currencies also appreciated against the dollar (except for Hong Kong’s currency, which is linked to the U.S. dollar).
INVESTMENT OUTLOOK
The signs of stabilization in the financial sector that began to emerge in April bode well for a broader global economic recovery.
It is our view that U.S. REITs are approaching the halfway point in the deleveraging process. The first to re-equitize were the “Realty Majors,” the companies that we believe have the best properties and managements. The share prices of these REITs have appreciated nicely. With access to multiple sources of capital, these companies will be well-suited to take advantage of distressed acquisition opportunities over the next few years.
Despite the likelihood of further declines in occupancies and market rents in the United Kingdom, property values appear to be stabilizing for prime London real estate. We have seen a recent pickup in fundraisings slated for U.K. property by real estate companies as well as investment managers. In our view, this underscores the appeal of high-quality properties with long leases and stable tenants that offer attractive income streams over time.
The strong domestic demand that has aided France’s growth in recent years is likely to be flat in 2009. Retail companies that derive significant revenues from non-discretionary items will likely hold up the best. Companies with weaker balance sheets will be under increasing pressure to raise equity, with such activity possibly beginning this summer.
Hong Kong has revised its full-year 2009 GDP forecast and now expects a contraction of 5.5% to 6.5%. While rising unemployment remains a concern, recent residential transaction volume has improved, with banks competing to put liquidity to work in an environment of historically low interest rates.
Japan’s property market is likely to lag a global cyclical recovery, if history is any indicator. We view the market’s developers as relatively attractive, with J-REITs being generally more expensive. At some point, we expect J-REITs to start to raise capital in order to strengthen their balance sheets.
The Reserve Bank of Australia, which left the official cash rate of 3.0% unchanged in May, will likely resume rate cuts if unemployment continues to rise. While recapitalization has improved the balance-sheet strength of certain Australian property companies, the trend has yet to fully run its course.
Singapore’s economic contraction is slowing, but likely to persist through 2009 as the global recession takes its toll on manufacturing, tourism and financial services. We prefer the larger, more liquid names, particularly among domestic residential companies.
More broadly, we continue to focus on companies with conservatively leveraged balance sheets that should be able to take advantage of attractive acquisition opportunities.
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.
1 Country returns are in local currencies as measured by the FTSE EPRA/NAREIT Developed Real Estate Index
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