Assessing the resilience of global listed real estate and lessons learned by the sector
In recent years, global listed real estate has delivered strong relative returns for investors while also taking significant strides in addressing the issues that affected the sector during the financial crisis of 2007/2008.
While the asset class has moved on, asset allocations have not. Therefore, it’s important for SMSF investors to understand global listed real estate as an investment opportunity.
This is the first in a two-part series that looks at the dynamics of the global listed real estate sector in the first part, and how the sector has addressed its risks in part two.
The average asset allocation to listed real estate from defined benefit pension funds in the US – a reasonable bellwether given its status as the largest segment of the largest pension market in the world – is a mere 0.6%1. Even more telling is that this allocation has barely changed over the last five years.
This is surprising given the scenario of moderate growth, low interest rates and low inflation that has persisted and appears to be accepted as the ‘new normal’. The sector has naturally participated in the post-financial crisis economic recovery with both improvements in employment growth and consumer spending generating demand for a commercial real estate across a number of sectors.
Meanwhile, new supply has generally been muted due to limited appetite from banks to fund speculative development, particularly within the context of an increasingly stringent regulatory environment coupled with a still-modest economic backdrop.
Similarly, the introduction of accommodative monetary policy in most major economies globally has also been extremely supportive for the asset class. The advent of negative interest rates in both Japan and Europe has emphasised the “yield replacement trade” and the relative attraction of investments with a healthy income component such as global listed real estate. While the US Federal Reserve is expected to raise interest rates at some point within the next twelve months, it is expected it will act with caution and the pace and quantum of interest rate hikes are expected to be gradual, notwithstanding the outcome of the US election.
With elements of weakness in several leading economic indicators and some market participants revising the odds of a global recession risk upwards, it is timely to assess the resilience of listed real estate as an investment class should the bear case regarding an economic slowdown indeed materialise.
The financial crisis proved a particularly challenging experience for investors in global listed real estate. It is within this context an assessment of resilience is required. The sector has learnt from its past by addressing financial leverage, development risk, payout ratios and its engagement with sovereign wealth funds.
Overall, global listed real estate has safeguarded itself from the possibility of an economic slowdown, to a far higher degree than ever before, particularly compared to the years preceding the financial crisis.
There is potential for further improvement over the near term. The result is an investment class that is well positioned to deliver real estate-like returns with the benefit of both liquidity and diversification.
Nevertheless, it’s worth exploring whether global listed real estate will outperform within a diversified portfolio if a global economic slowdown were to transpire.
Global listed real estate has outperformed the majority of other asset classes for eleven of the last 15 years and has significantly outperformed global equities since March 20092 . In addition, analysis published by CEM benchmarking in June 2016 shows global listed real estate has been the strongest performing asset class on a net-of-fee basis over the 16-year period from 1998 to 2014. This would further suggest listed real estate should be a key constituent within a diversified portfolio.
Why has listed real estate outperformed?
As an asset class, commercial real estate has been a key beneficiary of the global economic recovery. The economic environment that has persisted in recent years of moderate economic growth, driven by a gradual rise in employment and consumer spending has provided a strong backdrop against which listed real has outperformed.
Likewise, the sector has benefitted from the unprecedented fall in global interest rates, and with negative interest rates moving from the realm of economic theory to reality across a number of markets, this trend has become intensified. Increased liquidity, debt diversification, and the subsequent fall in margins have only served to further support global listed real estate.
Yet if global listed real estate is correlated to the performance of the global economy, conventional wisdom would suggest it should underperform in the event of a global economic slowdown – as the sector did during the financial crisis.
This is a valid concern and why it is important to assess how global listed real estate companies will fare during the next period of uncertainty, given potential emergent risks regarding the global economic outlook.
The next instalment in this series will explore how the sector has addressed financial leverage, development risk, payout ratios and exposure sovereign wealth funds following the financial crisis.
1. CEM Benchmarking, June 2016
2. Novel investor, UBS