Halfway through 2017 the global listed sector is performing better than I had expected, up over 7% Total Return in USD terms, although much of this is down to dollar weakness with the sector up just 2% in sterling and flat in euros. But the big moves for a dollar investor have been in Asia (ex Japan) which is up c. 20% and Europe up 14%. The UK is showing a very credible TR of c. 10% in spite of the political uncertainty which is starting to impact domestic business, consumer and investment decisions.
The big moves within the US are interesting with the regional mall REITs down 10%, and strip centers (adopting the US spelling!) down 18%. Given my views on retail, none of this is surprising, but office REITs at <3% TR are slightly disappointing, although industrials/logistics saw a very solid 10% TR. The big wins in the US came from the alternative sectors: data centers up c. 30%, and lodging and healthcare both up 20%. I participated in the data center move but feel short of lodging (I was worried about supply…) and healthcare (the politics!). The data center performance is very material and makes complete sense given the exponential rise in date use and storage, but it is hard to gain listed exposure outside the US. In the UK we have Segro where the data centre portfolio is under-estimated – not only is logistics and last mile demand strong in the UK (and improving in Europe), but the data centre market is also powering ahead with high barriers to entry. Twenty years ago I imagined all data going through the air (or a ‘cloud’ as it turned out) and that data centers would be obsolete, but the need for highly specified physical storage in locations close to major power supplies remains undiminished.
In Europe, we have seen some solid moves from real estate stocks in Germany (strong underlying data in the residential sector) and France (le Macron effect), but the bigger moves have been in Italy (as the threat of a banking crisis is reduced) and Scandinavia (helped by the Blackstone bid for Sponda, which raises an interesting question as to whether there is more PE driven M&A to come). All this against a background of big general equity flows into European equities on the back of better economic data, a benign outlook for interest rates (in spite of mixed messages from Draghi) and concerns about ratings in US equities.
The surprise perhaps is that the UK has held its own, but coming from a low base (with share prices on fat discounts to NAV at the start of the year). Tenant demand in London offices has remained robust in spite of Brexit and political uncertainty, and new supply is being deferred. We have seen reports of c. 7msf of new London office development deferred and some developers believe this will prove conservative. So while new and potential new office demand is expected to slow, we could have shortages of Grade A offices on a three to four year view.
Meanwhile the relentless advance of WeWorks in the serviced office sector continues with another major letting from Almacantar. There is no question that the millennials love this way of working, and importantly it’s not just SMEs taking this space (and free beer on tap!) but major corporates and professional firms as well. Visiting WeWork in Moorgate is mightily impressive and others want to be in this sector, whether it’s Blackstone buying into TOG, or British Land experimenting with its own flexible office brand. However investors in the listed sector are cautious on the REITs taking too much exposure here: the perception (rightly or wrongly) is that income is less secure, services come at a cost, and there is no way BL can compete with the global connectivity which a WeWork or a Regus (note the Spaces product from Regus provides a very contemporary offer) can provide its customers. Meanwhile the rapid growth in the serviced office market and its capacity will further weaken the second-hand office market where availability is rising.
The big news in the UK is that the equity market would appear open for real estate issues, and in particular anything with yield (including residential) and inflation protection. A cluster of small externally managed IPOs have listed or are in the process of listing, targeting the thirst for yield from income investors, and hoping that they will be able to replicate the paper machine of Tritax Big Box in the logistics space. History shows externally managed blind pools have a mixed track record, and the strength and credibility of managements and boards will be tested. And before too many of you write in, I have done my share of such IPOs! But where the opportunity is compelling and the management team exceptional (for example in the case of the Green REIT), then in my view it’s worth the investment (and reputational) risk. I certainly expect a far larger listed PRS in the UK, but some of these vehicles would be better scaling up privately first in order to prove economies of scale both operationally and financially, and prove they can operate a successful B to C brand, something few listed REITs have achieved in the UK (only Big Yellow and Unite come to mind), but it takes many years to establish such market leaderships, and the equity market is not always patient.
And the outlook for H2 this year? I still find it hard to find value and the recent (and rapid!) flattening of the yield curve is another reminder that the sector has been a massive beneficiary of monetary policy post the GFC and somehow this has eventually to reverse. And so I remain under-invested, particularly in the US, and underweight retail, but focused on sectors and countries seeing above average economic and rental growth, and in businesses with strong management expertise combined with low gearing. As rates start to rise, albeit slowly, I find myself now slightly less focused on dividend yield and more interested in genuine added value…
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