Global Listed Real Estate: 2018 Review & 2019 Outlook
Cash flow and dividend growth remain positive drivers for global listed real estate, while the impact of monetary and fiscal policies remains uncertain. The Duff & Phelps Global Real Estate Investment Team takes a look at how the asset class performed in 2018 and shares their expectations for the year ahead.
U.S. REITs, as measured by the FTSE Nareit Equity REITs Index, returned -4.6% in 2018, relatively in line with the -4.4% return of the broader U.S. equity market, as measured by the S&P 500® Index. The benefit of lower correlation was visible in all quarters of the year, especially in the fourth quarter, with REITs outperforming U.S. equities by 6.8%.
U.S. REIT returns were anchored by their attractive dividend yield, steady cash flows and dividend growth, a strong private market bid and selective M&A, and attractive valuations in the face of increased economic uncertainty. U.S. tax law changes lifted the economy in the first half to higher rates of growth than the market felt could be sustained. Trade concerns, a modest number of Fed rate increases, and the Fed’s balance sheet unwind were top of mind. Global macro-political volatility added to broader market defensiveness and helped more defensive sectors within U.S. REITs outperform, including the less cyclical freestanding retail, manufactured homes, and healthcare property sectors.
International real estate securities underperformed U.S. REITs, hurt by a stronger U.S. dollar. With the exception of Japan, Sweden, and Germany, all of the major international real estate markets underperformed the U.S. on a U.S. dollar basis. A stronger dollar and geopolitical trade and growth concerns were negative drivers of international total return performance.
Looking ahead, we expect continued variance in the global economic growth picture and regional real estate fundamentals. Regionally, we are looking to Ireland, Australia, and the U.S. for economic growth leadership. We expect the variance in global growth trajectories to create opportunities for active managers such as ourselves, who are focused on owner-operators of high quality real estate, with solid balance sheets and proven management teams, to deliver outperformance versus the broader REIT market. Overall, we expect cash flow and dividend growth for global real estate securities to be solid once again in 2019. Key themes we are focusing on include:
- Rents, not rates: While there is likely to be upward pressure on interest rates in many markets, rental rate growth – particularly for high quality real estate, will continue to support further cash flow and dividend growth.
- New supply: While new supply levels are generally catching up to years of undersupply, selective geographic markets and property sectors will remain impacted by new development.
- Balance sheet health: Cash flow and dividend growth rates are converging across many global markets, but U.S. balance sheets are benefiting from more active pruning and remain better positioned with less leverage than most international markets.
- M&A tailwind: M&A activity picked up in 2018, driven by healthy discounts to NAV in public real estate security markets, as well as large pools of private equity real estate capital looking to be put to work. We expect this to continue in the year ahead.
Our base case total return drivers for global real estate in 2019 include:
- Attractive estimated cash flow growth of 4-6%.
- Dividend yield of approximately 4%, with above average growth expected in the U.S. given lower payout ratios.
- Healthy demand, increasing rents, and manageable new supply driving cash flow and dividend growth.
- From a global perspective, real estate fundamentals remain more attractive for the industrial/logistics and data center property sectors with secular tailwinds from e-commerce and the cloud.
There are several potential upside catalysts to our base case. A key macro consideration would be greater-than-expected global economic growth, which would drive higher real estate occupancies and rents. Another upside factor would be rotation into real estate securities from bonds and broader equities, as investors embrace asset classes which provide diversification benefits alongside traditional allocations. And the increased potential for M&A and privatizations continues to exist given the listed discounts to private real estate market prices, robust bids, and ongoing appetite for high quality, core real estate among institutional investors.
From a balanced perspective, we also note certain downside risks to our base case assumptions. A key risk would be ongoing waves of macro-political shocks, which could lead to broad-based economic deceleration or a dislocation in global debt markets. Also, interest rates could increase at a faster pace and magnitude than a lift in net operating income growth and replacement costs could absorb. And an acceleration in the pace of new commercial real estate supply would also be a concern.
We will continue to closely monitor broad global macro drivers such as diverging monetary and fiscal policies, potential central bank pausing, and ongoing geopolitical risks. But overall, we believe the global real estate market cycle still has room for further growth against a backdrop of solid catalysts which underpin our base case.
The FTSE Nareit Equity REITs Index a free-float market capitalization-weighted index measuring equity tax-qualified real estate investment trusts, which meet minimum size and liquidity criteria, that are listed on the New York Stock Exchange, the American Stock Exchange and the NASDAQ National Market System. The FTSE EPRA/NAREIT Developed Index (net) is a free-float market capitalization-weighted index measuring publicly traded equity REITs and listed property companies from developed markets, which meet minimum size and liquidity requirements.The S&P 500® Index is a free-float market capitalization-weighted index of 500 of the largest U.S. companies. The indexes are calculated on a total-return basis with dividends reinvested. The indexes are unmanaged, their returns do not reflect any fees, expenses, or sales charges, and they are not available for direct investment.
Risk Considerations: Equity Securities: The market price of equity securities may be adversely affected by financial market, industry, or issuer-specific events. Focus on a particular style or on small or medium-sized companies may enhance that risk. Real Estate: The fund may be negatively affected by factors specific to the real estate market, including interest rates, leverage, property, and management. Industry/Sector Concentration: A fund that focuses its investments in a particular industry or sector will be more sensitive to conditions that affect that industry or sector than a non-concentrated fund.
The commentary is the opinion of the subadviser. This material has been prepared using sources of information generally believed to be reliable; however, its accuracy is not guaranteed. Opinions represented are subject to change and should not be considered investment advice or an offer of securities.
FTSE International Limited ("FTSE") © FTSE 2019. FTSE® is a trade mark of the London Stock Exchange Group companies and is used by FTSE International Limited under license. Nareit® is a trade mark of the National Association of Real Estate Investment Trusts (“Nareit”) and EPRA® is a trade mark of the European Public Real Estate Association (“EPRA”). All intellectual property rights in the FTSE indices vest in FTSE, Nareit and EPRA. Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices or underlying data. No further distribution of FTSE Data is permitted without FTSE’s express written consent. All indices, trademarks and copyrights are the property of their respective owners.