GLOBAL REAL ESTATE SECURITIES MARKET COMMENTARY Q3 2016 EXECUTIVE SUMMARY GLOBAL REAL ESTATE STOCKS ARE UP 10% THROUGH SEPTEMBER Real estate shares moved higher during Q3 to finish up over 10% yearto-date through September. Property companies have outperformed broad equities and bonds year-to-date with performance underpinned by attractive dividend yields and stable earnings growth. REAL ESTATE EARNINGS AND VALUES CONTINUE TO GROW We expect third quarter earnings to come in largely as expected as a “bottom-up” view of the world through the lens of property company earnings indicates that the real estate business is relatively healthy. Real estate fundamentals are strong as a result of stable to improving occupancies, higher rents, and active transaction markets. GLOBAL PROPERTY STOCKS OFFER PROSPECTS FOR POSITIVE TOTAL RETURN OVER THE NEXT 12 MONTHS We have a positive outlook for global real estate. We expect global property companies to continue to attract investors seeking dividend yield supported by stable earnings growth in a low growth world. With dividend yield in ~4% range globally, and earnings growth in the 6% range this year and next, listed real estate companies are well positioned in a low interest rate, moderate growth economic environment. Subdued development starts, a low inflation environment, and a wide spread between initial yields on real estate and high quality bonds should support investor demand for real estate. U.S. REITS BECAME THE 11TH GICS (GLOBAL INDUSTRY CLASSIFICATION STANDARD) SECTOR ON SEPTEMBER 1ST Equity REITs reached an important milestone on September 1st when they moved from the Financials Sector of the GICS classification standard into a new 11th sector called Real Estate. GICS is the leading global listed equity classification system, maintained by S&P Dow Jones Indices and MSCI, Inc. and, as such, is a significant acknowledgement by leading index providers that real estate investment trusts deserve a distinct representation among the now eleven major equity groups. By becoming a standalone sector, U.S. REITs will demand a more visible asset allocation decision by institutional investors who will have to be more specifically dedicate resources to cover the sector. We believe that this will be positive for REIT demand over time.
Exhibit 1: Global Real Estate Securities Performance as of September 30, 2016 Q3 2016
Source: FTSE EPRA/NAREIT Developed Index in USD - Net of Withholding Tax as of 09/30/2016. An index is unmanaged and not available for direct investment. Past performance is no guarantee of future results.
MARKET PERFORMANCE REVIEW GLOBAL REAL ESTATE STOCKS UP 10% THROUGH SEPTEMBER Real estate shares were modestly positive for the Q3 and have generated over a 10% total return for the first nine months of 2016. Listed real estate stocks globally have moved steadily higher as the result of investment characteristics including attractive current yield via the dividend underpinned by stable earnings growth, conservative balance sheets and improving property fundamentals. Property companies in the Asia Pacific and European regions outperformed in Q316, led by strong returns in Hong Kong as well as Continental Europe. Year-to-date, North American companies along with those in the Asia-Pacific region have outperformed. European total return has been bogged down by negative returns in the U.K., which have sagged as the result of the late June Brexit vote which put into motion a long process clouded by political uncertainty. A weak British Pound has exacerbated the weakness for unhedged investors based outside the U.K. Real estate stocks have out-performed broad equities and bonds year-to-date through September 30th. Property companies have performed well against a backdrop of accommodative central bank monetary policy which has kept interest rates and the yield curve low relative to history, as economic growth has remained sluggish and as the â€œlower for longerâ€? interest rate environment becomes an increasing reality. This is despite a well-telegraphed intention by the U.S. Federal Reserve Bank to raise policy rates most likely in its December meeting, which will prospectively put some upward pressure on interest rates which otherwise remain historically low. The yield on 10-year Treasury finished at 1.60% at the end of the third quarter versus 1.47% at the end of Q216 and 2.27% at year-end 2015. Exhibit 2: Global Real Estate Total Returns as of September 30, 2016 30% 25%
10% 6.1% 4.1%
0.6% 0% -0.1%
-10% -15% -20% -20.1% -25% Hong Kong
Source: FTSE EPRA/NAREIT Developed Index - Net of withholding taxes in USD as of 09/30/2016. Please refer to the last page for index performance in other major currencies. An index is unmanaged and not available for direct investment. Past performance is no guarantee of future results.
U.S. REITS BECAME THE 11TH GICS SECTOR ON SEPTEMBER 1ST Equity REITs reached an important milestone on September 1st when they moved from the Financials Sector of the GICS classification standard into a new 11th sector called Real Estate. This is the first new GICS sector created since it was defined in 1999. GICS is the leading global listed equity classification system, maintained by S&P Dow Jones Indices and MSCI, Inc. and, as such, is a significant acknowledgement by leading index providers that real estate investment trusts deserve a distinct representation among the now eleven major equity groups. Real Estate is the eighth largest GICS sector, with a 4% weight of in the S&P Total Market Index. REITs have grown significantly by market capitalization over the past 20 years and now represent approximately 13% of all institutional quality real estate in the U.S. With this, REITs have become an actionable way for investors to access a significant asset class in a liquid format. REITs bring balance sheet discipline, quality management, transparent financial results and clear communication to a real estate sector which has historically been dominated by private investors and lacked many of these attributes. By becoming a standalone sector, U.S. REITs will demand a more visible asset allocation decision by institutional investors who will have to be more specifically dedicate resources to cover the sector. We believe that this will be positive for REIT demand over time. Global Real Estate Market Commentary | Page 2
MARKET OUTLOOK GLOBAL PROPERTY STOCKS CONTINUE TO OFFER PROSPECTS FOR POSITIVE TOTAL RETURN Real estate companies offer many investment attributes currently desired by investors, including attractive cash flow and dividend yields, stable underlying earnings growth, conservative and well-managed balance sheets, and a strong bid by private capital seeking for hard assets. We believe that global property companies will generate positive total return of 5-10% over the coming twelve months. Positive yet sluggish economic growth combined with historically low long-term interest rates bodes well for real estate and real estate securities versus other asset classes. The slower pace of economic activity, subdued development starts, a low inflation/low interest rate environment, and a wide spread between initial yields on real estate and high quality bonds should support investor demand for real estate. Central bank policy will remain accommodative, including the U.S. Federal Reserve Bank which we expect to raise policy rates only after seeing a very consistent stream of positive economic data. We expect continued monetary stimulus to help mitigate any economic slowdown. Listed property company earnings will generally be unaffected in this environment, with stable to improving occupancies, higher rents, and active transaction markets. The Brexit referendum vote has caused global economic forecasts to be revised modestly down from already sluggish levels as the Brexit impact is largely a UK, and to a lesser extent Continental European, phenomenon. Economic projections elsewhere have been negatively impacted, particularly in Continental Europe. Economic impact beyond Europe however is expected to be minimal. While risks have become more elevated in the aftermath of the Brexit vote, we continue to believe any meaningful volatility creates a potential opportunity to buy high quality real estate companies with visible earnings at discounted prices. Exhibit 3: GDP Growth Forecast 8 2015 2016F 2017F 6
2018F LT Average
Source: Oxford Economic Forecasting as of 10/24/2016 Note: Countries ranked, left to right, by the difference between the forecast for 2016 and the long term average rate. Long Term Average (LT Average) is the geometric average of GDP growth rates for 1998-2015, with the exception of China, where CBRE Global Investors’ estimates the LTA. Historic data 1998-2014, and forecasts for 2016F-2018F come from Oxford Economic Forecasting. “F” refers to forecasts. Information is the opinion of CBRE Clarion as of the date of this presentation, which is subject to change and is not intended to be a forecast of future events, guarantee of future results, or investment advice. Forecasts and any factors discussed are not a guarantee of future results.
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DIVIDEND GROWTH REMAINS STRONG Current income generated by listed propertyâ€™s dividend yield remains a defining investment characteristic of the sector. Listed property companiesâ€™ dividend yield currently averages ~4% globally and is growing at a very healthy clip. We project average dividend growth to be slightly ahead of earnings in 2016 and 2017, driven by a combination of improving company cash flows as well as an expansion of dividend payout policies which remain conservative. Increasing dividends are emblematic of healthy companies in improving markets. Exhibit 4: Forecasted Dividend Growth
Weighted Average Dividend Growth
9.6% 9.6% 8.5% 8.0% 7.3%
6.2% 5.6% 5%
Asia-Pacific 2016 Forecast
Source: CBRE Clarion as of 09/30/2016, which is subject to change and is not intended to be a forecast of future events, a guarantee of future results, or investment advice. Forecasts and any factors discussed are not indicative of future investment performance.
Exhibit 5: Current Dividend Yield 6%
Global Dividend Yield: 3.7%
-2% Dividend Yield Current Spread Historical Spread
5.5% 4.5% 3.3%
4.6% 2.7% 1.1%
4.5% 2.7% 0.1%
4.1% 3.9% -0.1%
3.7% 3.1% -1.6%
3.6% 2.0% 1.1%
3.5% 2.6% -1.6%
2.5% 2.5% -0.8%
Source: CBRE Clarion, FactSet and Bloomberg as of 09/30/2016. Not all countries included. Historical spread is from 1990 for all countries except: Canada is from June 1994 and Singapore is from June 1998. Past performance is no guarantee of future results. Yields fluctuate and are not guaranteed. This information is subject to change and should not be construed as investment advice.
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EARNINGS GROWTH IS STEADY IN THE 6-7% RANGE A “bottom-up” view of the world through the lens of property company earnings indicates that the real estate business is healthy, with generally improving fundamentals and solid earnings growth. Earnings growth of real estate companies has largely come in as expected in 2016 to-date and in many instances revised up during the year. For example, among U.S. REITs during Q2 earnings, approximately 60% beat consensus earnings expectations, 23% met and 17% missed. Net operating income has been revised up during the year in the U.S. industrial, office and data center sectors but have been more challenged in the decelerating apartment sector and lodging sectors. Fundamentals have remained weak in a number of the Asian markets including Hong Kong retail and Singapore office, both of which are suffering from the headwinds of a decelerating China and less demand from luxury spending, although recent data suggests some level of stabilization in Hong Kong. Earnings among European property companies benefit from long lease-term in the case of the U.K. and gradual improvement on the Continent but are otherwise decelerating at this point in the real estate cycle. Office vacancy in London currently is very tight in the 3% range despite anxiety surrounding the longer-term implications on rental growth from Brexit. Exhibit 6: Regional Earnings Growth Forecast 15%
Hong Kong/ China
Source: CBRE Clarion as of 09/30/2016. Information is the opinion of CBRE Clarion , which is subject to change and is not intended to be a forecast of future events, a guarantee of future results, or investment advice. “e” refers to estimates. “f” refers to “forecasts”. Forecasts and the factors noted are not indicative of future investment performance.
CAP RATES SHOULD REMAIN STEADY IN 2016 The spread between cap rates and 10-year sovereign bond yields remains at historically wide levels, and suggests that there is plenty of “cushion” should bond yields ultimately increase, which near-term appears unlikely. Looking out over the next six to twelve months, we expect long-term rates to remain low given continued sluggish economic growth globally, generally accommodative central bank policy, a decelerating China, implications of Brexit and current negative rates in Europe and Japan. The yield curve is expected to remain flatter than in many previous economic recoveries, meaning yields on longer-dated debt should remain relatively stable. Given the significant current spread between cap rates and government bond yields, we do not forecast a material increase in cap rates this year.
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LISTED REAL ESTATE REMAINS ATTRACTIVELY VALUED VERSUS PRIVATE MARKET REAL ESTATE, PARTICULARLY IN U.S. “CORE” PROPERTY TYPES Listed property companies at September 30th traded at an estimated 5% discount versus the private market estimated net asset value (NAV). The implied global weighted average cap rate of 5.6% compares favorably to fixed income alternatives and a cost of capital which remains historically low. In the U.S., the modest premium is driven by pricier net lease, health care and date center property types while the “core” real estate sectors of apartments, retail, office, industrial, and lodging remain at a discount to our estimate of private market value. The U.K. “majors”, with significant portfolios concentrated in London, continue to trade at discounts exceeding 15% post Brexit. Implied cap rates for many of the U.K. majors are in the 5% range. Many Asian developers trade at over a 35% discount to NAV, materially below their long-term averages with implied cap rates in many cases exceeding 6%. A key observation and insight globally is that cap rates have remained low given negative policy rates, low bond yields, low levels of inflation and wide spreads between cap rates and the cost of capital. A significant amount of “dry powder” from investors in the private markets, including private equity, pension funds and sovereign wealth, too, is underpinning cap rates. Over $200 billion of estimated “dry powder” remains available in the U.S. alone for prospective investment in commercial property, before taking into account any leverage. Exhibit 7: NAV Premium/Discount by Region 10%
10 Year Average Current NAV Premium / Discount
10 Year Average NAV P/D
Current NAV P/D
-30% Continental Europe
United States All Sectors
United States "Core" Sectors
Hong Kong/ China
Information is the opinion of CBRE Clarion as of 09/30/2016, is subject to change and is not intended to be a forecast of future events, or a guarantee of future results, or investment advice. Forecasts and any factors discussed are not indicative of future investment performance.
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REAL ESTATE COMPANIES CAN PERFORM WELL IN THE FACE OF RISING INTEREST RATES While a short-term move higher in interest rates typically can cause short-term dislocation among yield-sensitive asset classes, including the listed property company sector, history suggests that property company shares ultimately benefit from the underlying forces that cause rates to move higher, namely positive economic growth. When examined more closely globally, evidence is such that property shares generally perform well in a capital markets environment with higher bond yields. The following chart shows the 12-month performance in U.S. property shares during periods in which U.S. interest rates rise and fall. While the positive returns during periods of rising interest rates may buck conventional wisdom for some, the favorable performance is not surprising given that improving economic conditions also tend to lead to improvement of the revenue line for owners/operators of commercial property and that this over time typically more than offsets any increase in debt expenses. Exhibit 9: REIT Performance in a Rising Interest Rate Environment
Average 12-month Performance of Real Estate Securities versus other Asset Classes, December 31, 1994 â€“ September 30, 2016 U.S. 10-Year Rates Falling
U.S. 10-Year Rates Rising
-50 to 0 bps
0 to +50 bps
U.S. Core Bonds 8.7%
Real Estate 13.2%
Real Estate 25.2%
Global Equity 22.6%
U.S. Corporate Bonds 8.7%
U.S. Equity 10.1%
Global Equity 17.7%
U.S. Equity 22.1%
U.S. High Yield Bonds 4.4%
Global Equity 8.2%
U.S. Equity 16.7%
Real Estate 21.0%
U.S. Equity 2.6%
U.S. High Yield Bonds 7.2%
U.S. High Yield Bonds 12.4%
U.S. High Yield Bonds 11.9%
Real Estate -0.2%
U.S. Corporate Bonds 6.2%
U.S. Corporate Bonds 5.6%
U.S. Corporate Bonds 3.0%
Global Equity -1.8%
U.S. Core Bonds 5.3%
U.S. Core Bonds 4.2%
U.S. Core Bonds 1.6%
Note: Performance shown represents the average 12-month total return for each asset class shown when bond yields moved by the amount indicated at the top of each column. Source: CBRE Clarion as of 09/30/2016 in USD. Real Estate, Global Equity, U.S. Core Bonds, U.S. Equity, U.S. High Yield Bonds, U.S. Corporate Bonds represented by FTSE EPRA/ NAREIT Developed Index, MSCI World Index, Barclays U.S. Aggregate Bond Index, S&P 500 Index, Barclays U.S. Corporate High-Yield Index, Barclays U.S. Corporate Investment Grade Bond Index, respectively. Information is the opinion of CBRE Clarion, which is subject to change and is not intended to be a forecast of future events, a guarantee of future results, or investment advice. An index is unmanaged and not available for direct investment. Past performance is no guarantee of future results.
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REGIONAL MARKET OUTLOOK In the Asia-Pacific region, we like Australia and Japan. Australian investments are benefiting from an attractive combination of yield and growth, plus mergers and acquisitions activity which has recently increased given wide access to attractively priced capital by quality institutional investors, including listed real estate companies. In Japan, we prefer companies with exposure to the Tokyo office market, which continues to experience improved rental growth as vacancies approach the 4% threshold at which landlords enjoy increasing pricing power. We also like Japanese retail in urban locations which is benefiting from strong inbound tourism and consumer spending as well as J-REITs with access to robust acquisition pipelines from their sponsors. We remain cautious in Hong Kong and Singapore as the result of the indirect impact of weaker demand from mainland China, which is weighing on demand across all property types, although valuations are increasingly pricing this in. Property companies in the U.K. have rebounded but risk remains elevated. We believe property companies on the Continent will hold up better, depending on geography and property type. U.K. property companies have largely rebounded to pre-Brexit levels, but sterling remains down over 10% during this time period versus the USD, reflecting increased levels of risk. Given continued uncertainty surrounding the future economic and political relationship between the U.K. and EU, and issues surrounding where we are in the economic and real estate cycles, we believe an underweight position is appropriate in the U.K. We expect an average basket of U.K. commercial property in the private market to materially soften in gross asset value in the medium term (through 2018). U.K. retail values will fall less than London offices though and be viewed as a more stable asset class, particularly Class A regional malls. As such, we favor the more economically stable sectors of grocery-anchored retail, dominant regional malls and self-storage versus the more cyclical London office sector. We believe the Continental European listed property stocks will be less volatile than those in the U.K., but could come under pressure as the process of the U.K.â€™s withdrawal continues. We consider our positions in the German residential and dominant European mall companies to be more defensive and therefore more desirable in this uncertain environment. Our positioning in the Paris office market would benefit from any future relocation of companies from the U.K., as well as from gradually improving office fundamentals, but both will take time. We remain selective on the office markets in Paris and on the Continent. We believe the U.S. will outperform as investors seek favorable risk-adjusted total return. In the U.S., we prefer attractively valued stocks that offer visible earnings growth, conservative balance sheets and modest development pipelines. Specifically, we favor the class A mall companies, data centers, industrial, shopping center and CBD office companies; we are more selective in the self-storage, suburban office, apartment and healthcare sectors. Apartments have underperformed in the face of supply concerns in coastal markets and decelerating top-line growth but are reaching more attractive valuations with still robust absolute growth. We remain selective on the more bond-like sectors that offer modest growth and trade at large premiums to our estimate of underlying private market real estate value.
IMPORTANT DISCLOSURES AND RISK INFORMATION The views expressed represent the opinion of CBRE Clarion Securities which are subject to change and are not intended as a forecast or guarantee of future results. This material is for informational purposes only. It does not constitute investment advice and is not intended as an endorsement of any specific investment. Stated information is derived from proprietary and non-proprietary sources which have not been independently verified for accuracy or completeness. While CBRE Clarion Securities believes the information to be accurate and reliable, we do not claim or have responsibility for its completeness, accuracy, or reliability. Statements of future expectations, estimate, projections, and other forward-looking statements are based on available information and managementâ€™s view as of the time of these statements. Accordingly, such statements are inherently speculative as they are based on assumptions which may involve known and unknown risks and uncertainties. The securities discussed herein should not be perceived as a recommendation to purchase or sell any particular security. It should not be assumed that investments in any of the securities discussed were or will be profitable. Actual results, performance or events may differ materially from those expressed or implied in such statements. Investing in real estate securities involves risks including the potential loss of principal. Real estate equities are subject to risks similar to those associated with the direct ownership of real estate. Portfolios concentrated in real estate securities may experience price volatility and other risks associated with non-diversification. While equities may offer the potential for greater long-term growth than most debt securities, they generally have higher volatility. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles, or from economic or political instability in other nations. Past performance is no guarantee of future results. The FTSE EPRA/ NAREIT Developed Index is an unmanaged market-weighted index consisting of real estate companies from developed markets, where greater than 75% of their EBITDA (earnings before interest, taxes, depreciation, and amortization) is derived from relevant real estate activities. Investors cannot invest directly in an index. PA10272016
Global Real Estate Market Commentary | Page 8
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Published on Nov 30, 2016
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