2016 was full of surprises, a year marked by the rise of populism, and underdogs ascending to the top. These two themes transcended throughout the fourth quarter, none more so than Donald Trump winning the election to be the next President of the United States. Also in the fourth quarter, OPEC against utmost cynicism finally found common ground, agreeing to curtail production by 1.2 million barrels per day, sending the price of oil to new 52 week highs. Interest rates on government bonds across most markets increased during the quarter as a result of better economic conditions and the prospects for higher inflation. Through all the noise, global real estate fundamentals chugged along but stock prices declined. Global real estate securities generated a total return during the fourth quarter of -5.4% in USD (-3.0% in CAD). The two best-performing markets during the quarter were Japan (+10.3% in Yen) and the United Kingdom (+0.6% in GBP), both of whom trailed the market during the calendar year 2016. We view the recent outperformance of both these markets as nothing more than a reversion to the mean. Canada, Australia and the U.S. took a breather during the fourth quarter (-0.1% in CAD; -0.8% in AUD; -3.5% in USD) after a strong first nine months (+17.8% in CAD; +14.0% in AUD; +11.9% in USD) while Continental Europe marginally outperformed during the quarter (-5.1% in EUR). Bringing up the rear was Hong Kong (-12.2% in HKD) and Singapore (-6.7% in SGD), both of whom experienced macro headwinds from currency and interest rate changes, none of which has impacted real estate demand and supply trends so far.
Our fundamental approach and valuation models suggest global REITs are priced to deliver an 8.5% to 10.5% total return in 2017, and will be influenced by:
- the potential for improving global economic growth and inflation;
- steady demand for space combined with modest new supply;
- discounted public market valuations as a result of the 8.8% decline (in USD; -6.3% in CAD) in the global REIT share price from August 1st to December 31st, 2016;
- low leverage levels (roughly 38%), which allow REITs to be acquisitive, as well as to take advantage of off-market opportunities and remain insulated from rising interest rates;
- mid-to-high-single-digit dividend growth, supported by low payout ratios and growing earnings, which could offer positive surprises as a result of economic improvements;
- continued mergers and acquisitions volume led by unspent real estate private equity capital commitments which aggregate to USD 230 billion; and
- new inflows from equity investors taking REITs to benchmark levels.
We believe the biggest risks to achieving our forecasted total return for 2017 include: • an acute spike in interest rates (i.e., greater than 150 bps), which will result in yield-oriented equities being temporarily out of favour;
- policy mishaps by newly elected political officials;
- slower-than-expected economic growth in China, which leads to a slowdown in global growth; and
- elections in the Netherlands, Germany and France, which may negatively impact the viability of the European Union.
As it relates to the markets themselves, we believe demand for industrial space in the United States from e-commerce tenants in 2017 will continue to remain strong, driven by healthy growth in online sales. U.S. student housing should experience another solid year of enrollment growth leading to higher rental rates. Lastly, we believe less financial regulation in 2017 and beyond, should that come to fruition, is good for banks and lending, which will have positive implications for New York City’s office market. In Canada, we expect retail real estate trends to remain stable over the next 12 months, characterized by steady cap rates and low vacancy rates.
In the United Kingdom, we believe student housing is poised to shine as office landlords grapple with higher tenant concession packages and modestly lower pricing power. In Germany, multifamily fundamentals should remain strong in 2017, particularly in Berlin as positive net immigration serves as a boon to landlord’s ability to push rents. In Sweden, office and retail real estate fundamentals are expected to remain strong supported by good economic growth. Across Continental Europe open-air grocery-anchored shopping centres should continue to experience relatively good traffic levels in 2017, supporting in-place rental levels and occupancy rates.
In Japan, we believe inbound visitor travel should remain strong in 2017, supported by a weaker yen. In Hong Kong, we believe mass market retail centres will experience stronger sales and rent growth compared to its luxury peers, escaping much of the headwinds taking place at higher end centres. In Singapore, we believe retail real estate is better positioned to experience less softness in fundamentals relative to other property types over the near term (due to less supply pressure). Finally, in Australia, we believe Sydney’s office market will deliver the strongest performance of any office market in the country, characterized by very solid net absorption and rising net effective rental rates.
We are cautious of investments in U.S. health care (specifically hospitals), multifamily properties in Calgary and San Francisco, office properties in London and Singapore, and luxury retail and residential buildings in Hong Kong.
All in all, we believe global real estate demand trends are firm and valuations are attractive, with global REITs trading at discounts to NAV and providing an attractive dividend yield that is fully covered, stable and growing.