On 1 September MSCI elevated listed real estate as a stand-alone sector in the global benchmark for equity indices and Standards & Poor’s is due to follow on Monday, we learned at the annual conference of the European Public Real Estate Association in Paris earlier this week.
The move is significant, Alex Moss, chairman of EPRA’s Research Committee, explained during a press conference. ‘This is the first time that a sector has been taken out of a broad sector and it’s certainly interesting in terms of timing. What this proves is that listed real estate is a separate asset class and deserves separate classification.’
In addition to MSCI and S&P, more index providers may make the change as well, he added.
The index tweak will shine the light on the listed real estate sector, Moss said. Indeed, EPRA estimates that Europe’s listed property could be in line for €75 bn in capital inflows over the coming years. ‘Generalist stock pickers will now have to take an explicit weighting on real estate,’ he explained. ‘And an increased profile for the sector will lead to greater levels of liquidity. Overall, what this means is that the listed real estate sector is being treated in its own right. The shift won’t happen overnight, but this move is important for the evolution of the sector.’
Listed real estate has come of age
One of the key drivers of the change is that size is becoming more important, Moss said. ‘But more importantly there’s now a growing awareness of the special characteristics of the listed real estate sector and REITS.’ REITs, which make up 70% of the total listed real estate sector, pay out dividends and offer a different risk profile, he noted. ‘These stocks have less volatility than financials.’
Elevation to a stand-alone sector in the Global Industry Classification Standard (GICS) - the reference for equity indices compiled by MSCI and S&P GICS - follows a tripling in real estate’s share of the global equities market to 3.5% currently, from 1.1% at the trough of the market cycle in 2009, EPRA’s CEO Philip Charls told the conference. During the same period a combination of equity fund raising and strong investment performance has powered a surge in the free float market capitalisation of the FTSE EPRA/NAREIT Global Developed Index to $1.48 tln (€1.32 tln) from $508 bn.
‘Global listed real estate has come of age,’ Charls said. ‘A stand-alone real estate sector is recognition that listed property companies are an important investment sector in their own right, standing shoulder to shoulder with telecommunication services, healthcare and other mainstream industries.’
Rebalancing to the Continent
Within the European listed real estate universe, companies on the Continent currently look better placed to benefit from any increased demand from equities investors, according to JP Morgan Chase real estate analyst Tim Leckie. In fact, he is advising investors in European listed property companies to avoid UK stocks, in particular London office specialists, and focus on companies in continental Europe that offer less risky income growth prospects.
‘The UK market is being buffeted by the headwinds of political and economic uncertainty following the momentous 23 June “Brexit” vote to leave the European Union. These aren’t going to lift any time soon, so while the slide in share prices has made the UK listed sector appear cheap, we recommend a focus on income-generating stocks in continental Europe that don't carry the Brexit risks.’
Leckie noted that Brexit has changed the outlook for London offices due to prospects of lower job growth, lower GDP, lower rental growth and negative capital growth. He also foresees continued uncertainty going forward. ‘Political risk is as clear as mud…The problem for investors that go into London office stock is that they could be down 15% the next day even if the companies are overall in good shape.’
By contrast, investors can still get a premium on the Continent, he said. ‘We are big fans of German resi; we also see rental growth in the Paris office market, as well as Spain and Ireland. We like pan-European retail as well and also see some value in the smaller second-tier companies.’
Record yield gap
That said, a record yield gap currently exists between UK property stocks over the gilt, Leckie pointed out. ‘That suggests that investors think these shares are going to reprice massively or that a massive recession is coming. The yield gap should correct to historical standards but the signs are that property is still being overlooked by the broader market.’
Historically UK property companies have focused on developments, but since the crisis they have reined in new projects and are approaching the end of the cycle with ‘really strong’ balance sheets, he added. ‘There are no distressed sellers and property owners are extremely well financed. UK listed REITS can use their balance sheets to buy asset management plays to grow the top line and pump through dividend growth plus capital growth returns.’
Leckie said he would be surprised to see ‘swinging cuts’ in valuations despite some stress in leasing structures. ‘It’s still too early to say, but the listed market has done a good job of valuations. Some equity investors are saying ROI figures in the high single digits is not enough. It is. They should switch.’
He added that he expected to see a low interest rate environment for some time. ‘In that context property returns look increasingly more attractive than the broader market. We like the income and overall risk is off.’
Private equity is on the prowl
Some investors already get it. Asked during a panel of leading global real estate investors whether property investment yields can go any lower, Wen Sheong Linus Lim, head of Philip Capital Management, said that many investors were simply chasing income-yielding assets. ‘New normal yields are lower cap rates,’ he said.
Essentially global investors are having to come to terms with the fact that brick-and-mortar yields will likely remain tight given the weight of capital in an environment where bond yields are at historic lows. At the same time, one of the risks facing listed property stocks that continue to trade at a discount to NAV is that they will fall into the hands of private equity players like Blackstone, Leckie noted. UK-based Quintain has already been taken private by Lone Star and more delistings could follow given the current environment and the fact that private equity players have the money in place.
In other words, the more investors that understand the new normal, the better, Leckie said: 'The listed universe needs to get bigger not smaller. Privatisations would reduce the universe.’
Judi Seebus
Editor in Chief PropertyEU
