An on-off relationship?

After a tough period following the financial crisis, it appears REITs are now back in favour, Nadine Wojakovski finds

The onset of the financial crisis in 2008 brought a sharp contraction of liquidity into the real estate investment market and led to banks’ withdrawal from lending. This resulted in a very abrupt fall of underlying property values hitting highly leveraged investors. As a result, in the aftermath of the financial crisis there has been a much greater emphasis on income as a source of investment returns as opposed to the previous emphasis on capital growth.

“In this environment the attraction of real estate is that it offers less volatility than straight equities and a higher income yield than is available from the most secure bonds,” notes CBRE EMEA chief economist Peter Damesick. “That’s a key selling point.”

Damesick says that with REITs, as opposed to direct investment in property, you can build up more diversified exposure for the same investment outlay by buying a basket of shares in companies invested for example in Central London offices, major shopping centres and distribution warehouses. “It offers diversified exposure to investors with smaller portfolio allocations to real estate. Also through REITs you avoid the responsibility of directly managing the asset yourself.”

According to Damesick the best developed European REIT markets are in the UK, Belgium, France and the Netherlands. However, he says that in Spain, Italy and Germany the sector is not “well developed”.

It appears that REITs are back in favour. Earlier this year AMP Capital won a global REIT mandate from one of the largest pension funds in the world - China’s National Council for Social Security Fund (NCSSF). AMP Capital director of international business Anthony Fasso says it is one of the first Chinese institutional investors to invest offshore through external mandates and investment managers, thereby highlighting what he calls “the growing trend of Chinese offshore investing”.

The mandate will be benchmarked to the EPRA developed index and this constitutes of circa 33 per cent Asia, circa 14 per cent Europe and circa 53 per cent North America. “However, we will be making decisions as to whether we should be over or underweight the respective regions,” notes AMP Capital senior portfolio manager Tom Walker. Within Europe the largest investments are likely to be made in the UK, France and Germany. The fund plans to invest in all types of property, namely office, retail, industrial, hotels, storage, student housing etc. An investor can expect a return of around 6 to 8 per cent.

But Walker says that when looking at a global portfolio it is “very dangerous” to generalise. Hence returns, asset types and countries are all theoretical. “Across the globe there will be many interesting opportunities at any single point, however, they will change as markets change.” So he says they will be looking to take advantage of “mispriced securities” and therefore decisions will evolve over time.

Michelle Reuter is a senior associate of real estate at Mercer in the US. She says that one of the biggest issues that many REITs worldwide ran into during the global financial crisis was their overuse of leverage. However, she observes, over the past several years they have been able to successfully recapitalise and repair their balance sheets. “Today REITs are healthier than before and are proving their ability to take advantage of market dislocations and make accretive acquisitions.”

The good thing about global active managers is they can take advantage of where the different countries are with the market cycle and can move in and out frequently. “In North America it’s slightly overvalued, but in other parts of the world it’s undervalued, so we think there is an opportunity for clients to invest.”

She continues: “Many countries in Asia are also showing attractive valuations that REIT managers can take advantage of. In Europe with all headline news managers can move in and out as they see impact of property valuations. In continental Europe, managers are seeing discounts and opportunities to take advantage of. In the UK there is currently an even wider discount.”

She concedes that the volatility in the market has caused a little trepidation in the REIT market as investors want to wait and see if the volatility is going to subside. On the other hand she is finding clients attracted to REITs because they offer an attractive yield. In the beginning of 2009 she saw a “tremendous” amount of activity in REITs. Although it has trailed off now, she is seeing a small uptake. One reason being that they offer “attractive cash on cash returns” because of the low interest rate environment we are in.

According to Aviva Investors global head of REITs Paul van de Vaart, REITs have more than recovered their losses as investors have been attracted to the sector by the high spread between property yields and core government bond yields, high dividend yields and reasonable valuations. Indeed, he points out that the European real estate securities index has seen a total return of 27 per cent over the last two years (EPRA Developed Europe to 13 August), with 23 per cent of that performance having been made in the 7½ months year to date.

As for the €114m (as of 31 July 2012) Aviva Investors European Real Estate Securities Fund - it prefers the Nordic regions and continues to avoid southern Europe. Within the eurozone it prefers exposure to the German residential sector whereas in the UK it keeps a clear focus on companies with central London exposure.

Van de Vaart says that investor confidence in the real estate securities sector has largely returned, but acknowledges that more work needs to be done by the companies in order for shares to rerate further. “Leverage in the sector needs to be reduced further, especially as the outlook for values for anything outside of prime properties becomes less certain,” he offers. “We also firmly believe that REITs need to simplify their structures, with a clear focus on income generation and being less active developers.” Furthermore, he says he would like to see greater specialisation, with a clear focus on a specific strength in subsector or region.

While REITs are gaining popularity again their risks cannot be over-looked if and when market conditions change. One risk is the potential of a rising bond yield environment in Europe, reducing the attractiveness of the dividend yield. Another is leverage, especially for smaller companies with less prime portfolios. Also, the availability of bank loans to the sector is contracting.

Having said that, for now REITs are enjoying a revival. Generalist investors have come back to the sector due to its attractive dividend yields, compared to the steadily falling gilt and bund yields. They also offer investors an opportunity to get instant exposure to the prime parts of the recovering real estate markets.

They meet different objectives for different clients. For those who have direct property investment, they may use them for diversification or to add liquidity. For other clients, who can’t achieve global real estate exposure through direct means, they will use them for global diversification. “We like to provide each client with different types of managers according to their different risk/return objectives,” says Reuter. “Some might be more concentrated or some might be more like the benchmark. We determine what’s most appropriate for them.”

Significantly, this exposure to a ‘real asset’ has become more attractive in an uncertain macro-economic picture.

Written by Nadine Wojakovski, a freelance journalist

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