Property investors should look beyond the current languid growth in developed market economies and position their portfolios for a recovery in the world economy in 2013 and 2014, Mark Roberts the global head of RREEF Real Estate says.
Roberts, who also chairs the National Council of Real Estate Investment Fiduciaries (NCREIF), points to initial yield spreads for property, that are wide compared to bonds and real-estate capital values that remain well below peak levels, as indicators of the growing attractiveness of the asset class.
Along with potentially attractive valuations and solid income growth, Roberts says that the lack of new construction in developed markets in the US and Europe also adds to the case for investing in property.
“If you go back in time and buy when there is limited new construction, you stand a good chance of producing good relative performance. So it is the initial yield spreads, it is having values that are below replacement cost and it is also a limited amount of new development,” Roberts says.
“Now, is it like that everywhere? The answer is no. Globally what you have to look for is what are the cities that have exposure to the type of competitive advantages or industry concentrations that are going to benefit from any recovery.”
In its latest global market outlook, RREEF recommends being overweight the US and Asia Pacific region, while underweight Europe.
A typical global portfolio would be split 34 per cent between the US and Asia Pacific, with Europe making up the remaining 32 per cent.
Roberts argues that last year saw an inflection in the US property market, with vacancy rates falling as unemployment fell.
Typically, a 1 per cent fall in the rate of employment leads to a 1 to 1.5 per cent drop in commercial vacancy rates nationally, he says.
Roberts points to the initial yield spreads for property relative to bonds that have reached historic levels and stand in excess of 400 basis points, compared to a longer term average of 100 to 300 basis points as an indication of the attractive value of property.
In markets like the US and the UK, property prices are still at least 10 to 15 per cent off their peak levels, he says, with little new construction adding to limited supply of core, high quality properties.
RREEF predicts that total returns in a majority of markets and sectors globally will range between 6.5 and 11 per cent, providing similar returns to equity with less volatility.
Roberts expects these fundamentals to result in increased capital flows into property in 2012.
“Property has always been the smallest midget at the circus, so to speak,” he says.
“Property has come of age as an asset class and there is a lot more transparency in terms of the securities, debt and listed markets. People are able to price risk better and there is growing transparency globally.”
Allocations to property by large institutional investors are holding steady at between 8 and 12 per cent, according to Roberts.
Asian allocation to real estate rises
However, RREEF is seeing growing interest from Asia.
Niel Thassim, RREEF’s head of the Asia Pacific region, says that the manager has raised more than $2 billion from Asian investors in the past two years to invest in core properties in what he describes as gateway cities in developed markets.
RREEF expects growing capital flows into property from large pension funds in Japan, South Korea and China, which Thassim says have traditionally low levels of allocation to real estate of less than 1 per cent of portfolios.
“We are seeing a lot more exposure in Japan, Korea and China to real estate from the pension fund side,” he says.
While funds have typically been interested in the equity side of property, Thassim says there is also growing interest in debt opportunities in developed markets.
In the Asia Pacific region RREEF recommends targeting the retail and logistics sectors more broadly and the office sector selectively, particularly in Australia and Japan.
Retail and logistics-focused commercial space is aimed at tapping into the growing middle class in the region, with the need to upgrade obsolete properties to cater for growing demand.
These sectors are predicted to have stronger income growth than office and residential sectors.
In the US Roberts says that the modest pro-cyclical approach that focuses on the industrial and office sectors.
While apartments have performed strongly, Roberts argues that investors are “waking up to the industrial market” after seeing 125 million square feet of warehouse space absorbed nationally, which is a return to historical averages.
“The initial yields and the cap rates are 200 or 250 basis points higher than the apartment sector, so it has a higher income yield, and on the growth side, when you look at apartments you are only going to get growth through increases in rents for a couple of years,” he says.
“But when you look at the commercial sector, you get the benefits of declining vacancy, rent growth and rents growing up to market when you start looking out to 2013 and 2014.”
Roberts recommends investors look to cities and regions that will benefit from a recovery in global trade and/or have resilient competitive industries.
These include cities like Hong Kong and Singapore in Asia and in Europe trade centres such as the German city of Hamburg. In the US Roberts points to cities such as Boston and the San Francisco Bay area as examples of cities with industries that are resilient to economic downturns.