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After a strong performance of over 10% in 2015, the global real estate sector still looks attractive. Especially the prime retail and office space will offer good opportunities. This year, real estate will become a separate sector according to the Global Industry Classification Standard, which will have a favorable effect on flows.
Offering an expected dividend yield of close to 4% for the 2016 fiscal year, the global real estate sector looks attractive from an income perspective. In developed markets fundamentals are improving and 2016-2017E earnings growth rates are in the high single digits. As payout ratios are upped we expect dividends to rise accordingly.
Overall leverage for the listed sector is moderate with an average Net Debt to Enterprise Value of sub 30%. In the direct real estate market we see limited evidence of high leverage transactions as many deals are equity driven. However, fund flows from, for example, sovereign wealth funds, could come under pressure due to the lower oil prices and pressure on foreign reserves in emerging markets. This could have an impact on real estate volumes and pricing.
After a strong performance of more than 10% in 2015, we remain neutral on the sector’s valuation levels. Real estate stocks currently trade at a single digit discount to net asset values (NAVs). The sector could be vulnerable as short term rates in the US are on the rise and long-term interest rates could start to rise as well. The effect will greatly depend on the underlying cause of the interest movement. Meanwhile, cap rate spreads to local 10-year bond yields are still above historical averages.
Given the steep increase in BBB yields in December 2015, cap rate spreads versus investment grade credits are currently lower than the long-term average. We believe that large cap companies are in a relatively good position given diversity in funding sources and well spread debt maturity ladders. Despite the fact that spreads have widened recently in absolute terms funding costs are relatively low and refinancing opportunities still offer a silver lining for the industry.
As the global economy is still in a deleveraging mode, the Robeco Property Equities fund favors actively managed companies with strong balance sheets, low leverage and strong (free) cash flow profiles. The debt to equity ratio of the average holding in the fund stands at 1.2x versus 1.7x for the overall listed sector. Low levered companies are in a better position to either pursue acquisitions or start new (re)developments.
For the foreseeable future we expect limited supply of new commercial real estate and as such physical depletion could cause a shortage of high grade real estate. Real estate is a local phenomenon and we carefully monitor supply on a regional or even city-based level. Over the last couple of months global GDP estimates have come down. This could have an impact on office demand and result in a softening in rent growth.
‘This year, real estate will become a sector of its own’
Despite these cautious comments, we believe occupancies and rents will keep on improving, especially in the prime segment as tenants rationalize their physical presence to top locations such as Central Business District (CBD) areas. We believe this holds for both prime retail and office space. Combined with healthy supply levels this will create a landlord-favorable market in the coming years
A sector in its own right
This year the real estate sector will no longer be part of the financial sector but instead become a separate 11th GIC sector. Global real estate will represent roughly 3% of the MSCI Equity index. We expect more interest from generalists and a decreasing correlation with general equities and the financial sector in particular. And despite the fact that the correlation with long-term interest rates might increase, the overall risk-return profile of the real estate sector will underpin its attractiveness in the asset allocation decision.
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