PROPERTY VALUED
Why European real estate is ripe for the picking.
The U.S. has offered the best growth for global real estate investors in recent years, because extremely accommodative monetary policy has made financing extremely cheap.
The sector has also attracted a lot of capital flows as people started to put the money they kept in cash during the financial crisis to work.
But many didn’t necessarily want to buy regular stocks, due to the uncertainties about when earnings and economic growth would arrive, and others feared fixed-income products because of the prospect of higher interest rates. Real estate, however, provided a nice middle ground and that has led to rising property values.
As a result, Timbercreek Asset Management portfolio manager Corrado Russo thinks the low-hanging fruit is gone from the U.S. market.
He expects cap rates — the ratio of net operating income to property asset value — will stay constant, with more upside coming from earnings growth.
Europe, however, appears to be where the U.S. was three or four years ago, and that’s attracted Russo’s interest for the closed-end Timbercreek Global Real Estate Fund (TGF.UN/TSX) and a recently launched mutual fund that has many of the same exposures, the Timbercreek Global Real Estate Income Fund.
“We’ve obviously seen a pretty significant decline in interest rates across the continent,” he said. “Our view is this is driving cap rates lower and asset prices higher. We’ve already seen that start to happen and we think it is going to continue.”
Russo noted that 10-year bond yields in Germany, the Netherlands and France are down between 140 and 180 basis points since the start of 2014, and many pension funds are branching out into real estate and looking for assets in Europe.
Combine the low cost of financing with the high demand for product, and he expects to see some pretty significant gains in property values.
Russo is playing the cap-rate compression trend in Europe several ways, including through names such as French retail-focused company Mercialys SA and more diversified players like Germany’s TLG Immobilien AG.
However, he highlighted Dream Global REIT (DRG. UN/TSX), whose entire portfolio is in Germany.
“Dream has done an incred- ibly job of repositioning its old Deutsche Post assets, and buying high-quality portfolios,” Russo said. “We’ve seen a runup in the stock as people have appreciated this, but I don’t think the cap-rate compression has played its way into it.”
Although U.S. private real estate values remain relatively high, publicly listed REITs have fallen more than 10 per cent on the year as sentiment fades on fears of U.S. Federal Reserve rate hikes.
Ever y time Fed c hair Janet Yellen says anything — deemed right, wrong or neutral for the market — REITs get hit. But, as Russo points out, if interest rates are going up for the right reasons, such as growth and inflation, then the environment is actually quite good for real estate.
“Growth means more demand for real estate, higher occupancy and more pricing power, so cash flows will rise,” he said, noting REITs actually outperformed during seven of the past eight hiking cycles. “If inflation is higher, then the replacement cost of putting up a new piece of real estate goes up, and the existing piece of real estate becomes more valuable.”
The recent selloff is also creating opportunities related to M&A, with the portfolio manager recently selling Home Properties Inc. after a privateequity firm bought it out.
One name he thinks may be a consolidator is Stag Industrial Inc. (STAG/NYSE), which owns 265 institutionalquality big-box, single-tenant industrial assets such as warehouses and distribution buildings.
Since its IPO in 2011, Stag has grown its portfolio by about 250 per cent and its dividend has risen 33 per cent.
“They are seeing a lot of opportunities to buy companies and other portfolios, and they have a very attractive cost of capital given where their stock is trading,” Russo said.
Other themes the portfolio has exposure to include a recovery in Australian fundamentals with a position in high-quality regional mall operator Scentre Group Ltd. (SCG/ASX), as well as Singapore’s growing role as a gateway into Asia through warehouse and logistics companies.
Russo is also playing the Chinese government’s push to drive more foreign investment directly into the Shanghai stock market through connections with Hong Kong, with a position in Sunlight REIT (0435/HKG), whose property assets there make it an attractive opportunity.