SINGAPORE (Mar 4): Following a skittish fourth quarter last year, major equity markets have enjoyed a rebound since the beginning of this year. Amid this volatility, US real estate investment trusts have stood out for their credible showing over the past 12 months. Besides “solid” fundamentals, the REITs were helped by the dovish stance of the US Federal Reserve, says Suleen Law, Southeast Asia senior vice-president of business development and financial institutions at Neuberger Berman. These factors enabled REITs to outperform US equities over the past year, notes Law. “Many economic indicators, including high consumer confidence, strong non-residential fixed investment and modest inflation, point to good tenant demand for real estate,” she adds.
Wilson Magee, director of the Franklin Global Real Estate and Infrastructure Securities fund, agrees. He says the cash flow valuation of REITs appears to be attractive compared with equities. REITs are seen to post “stable” earnings growth, while equities are likely to face downward pressure. At the same time, the REITs are trading at relatively attractive valuations.
Unsurprisingly, REIT funds with a significant exposure to the US enjoyed a lift from these factors. Several of them dominated the top-performing Singapore retail funds table over the last 12 months to Feb 22, though many underperformed their respective benchmark index.
For instance, the Neuberger Berman US Real Estate Securities Fund, which was the best-performing fund, returned 17.5%, according to Morningstar data. It pulled off this outstanding performance despite a relatively small fund size of $124 million. The fund holds 34 REITs — 10 of which form slightly more than half of its assets under management, according to its Jan 31 factsheet. Its top three subsegment allocations are in infrastructure REITs, apartments and data centres.
The Franklin fund did well, too. According to Morningstar data, it returned 11.8% over the 12 months to Feb 22. The fund has more than half of its holdings located in the US, followed by Japan and Hong Kong, according to its Jan 31 factsheet. Its top three sub-segment allocations are diversified, residential and office REITs. Its three largest holdings are US-listed Simon Property Group, Prologis and Equity Residential. Asia-Pacific REITs have done well too.
This can be attributed to the positive outlook for the commercial property market in general, the region’s accommodative monetary stance and high dividend yields, says Victor Wong, senior director and head of Asean Equities, UOB Asset Management (UOBAM).
In particular, Japan REITs outperformed because of the strong demand for office space in the country. The office vacancy rate in Tokyo’s five central wards declined to just 1.9% in December, the lowest level in 27 years, despite an increase in office space supply, says Wong. In Singapore, the office, retail and business park rental rates recovered due to easing supply, he adds. The improved property outlook, together with a decline in bond yields, also provided support.
REIT funds such as the United Asia Pacific Real Estate Income Fund have performed well too, returning 13.9%, according to Morningstar data. The fund’s top three country allocations are Japan, Australia and Singapore, according to its February factsheet. Its top three subsegment allocations are office, retail and diversified REITs. Its top three holdings are Hong Kong-listed Link REIT, Australia-listed Scentre Group and Japan-listed Japan Real Estate Investment.
Challenging macro environment
Can REIT funds continue to do well for the rest of 2019? That, to an extent, depends on how macroeconomic and geopolitical events unfold in the coming months. For example, rapidly rising long-term interest rates pose the most significant potential challenge to funds. “While worries over rapid and significant increases in long-term rates have moderated recently, they have not abated permanently,” says Franklin’s Magee.
Paul Vrouwes, senior portfolio manager of the NN (L) Global Real Estate fund, agrees. “A sharp increase in interest rates is [usually] a headwind for the asset class, as real estate typically attracts investors looking for yield. [However], we believe there is a low probability for this [to happen] given the recent dovish tone by the [US] central bank amid concerns over the state of the global economy,” he says.
On one hand, the US economy is widely said to be in the late phase of economic expansion. On the other, China’s economy is decelerating. Unresolved trade tensions between both countries have only made things worse. This means global growth is likely to slow. “In our view, the biggest risk to [our fund’s] performance is an extended economic slowdown or recession,” Neuberger Berman’s Law says. “This would pressure both rents and occupancy, and in turn, real estate cash flows.”
Still, fund managers reckon that their funds will be able to weather the storms ahead. “Our bias towards higher-quality investments means that the companies we invest in operate with more conservative capital structures that fundamentally have less exposure to rising interest rates,” says Franklin’s Magee. “We also carefully consider company-specific risks to interest rate increases and analyse correlations related to interest rate sensitivity.”
Others like Law say they will rely on a rotation strategy. She says the Neuberger Berman fund constantly monitors and manages exposure by sector and region to find investments that can perform better in more challenging economic environments. “For example, we can increase exposure to defensive [subsegments] such as healthcare and net lease, and [have] lower exposure to cyclical [subsegments] like hotels,” she explains. UOBAM’s Wong says: “Given the diversified nature of Asia-Pacific REITs, we have the flexibility to shift our investments across different segments and markets. In the event of an economic slowdown, we will shift our focus to REITs [that] have a longer time period before their leases expire.”
Opportunities ahead
Where are fund managers seeing opportunities ahead? From a thematic perspective, Law says the new economy sectors are exciting. Technological advancements such as 5G, cloud computing, autonomous driving and artificial intelligence should lead to significant investments in network and information technology infrastructure, she says. “We believe data centres and infrastructure REITs, particularly those that own high-quality assets in key hubs of connectivity, are best positioned to benefit from these secular tailwinds,” says Law.
The office subsegment across major cities around the world is also looking attractive to fund managers. Eric Franco, portfolio manager of the AB Global Real Estate Securities Portfolio fund, points out that Tokyo’s office occupancy remains at historically high levels and rents continue to rise. Franklin’s Magee says rent growth in Stockholm and Sydney has been “impressive” and should be sustained on the back of favourable supply and demand characteristics.
In the US, most segments of the property market are characterised by “balanced” fundamentals, says AllianceBernstein’s Franco. For one, demand growth remains healthy and supply growth is normalising, he says. Cash flow growth is nearing average levels, while rent growth remains especially strong in dense markets along the East and West coasts. Furthermore, fundamentals in the self-storage sector have modestly weakened following an increase of new supply in several cities. “New supply is expected to remain elevated in the
year ahead,” he says. While REIT funds may continue to outperform this year, retail investors may be asking this question: Why put my money in these funds when I can invest directly in REITs?
For one, by doing so, investors avoid paying high fund management fees, enabling them to reap the greater rewards from their investments.
Investing in a REIT fund also provides advantages not easily attained by individual investors. Such funds provide diversification of risks, explains Chan Hock Fai, managing director and head of equities at Manulife Asset Management. This mitigates the concentration risks of investing in a handful of REITs, which he says could substantially affect an investor’s returns, if “one of them blows up”.
Additionally, investing in a REIT fund allows investors to tap the experience of a professional fund manager, says Wong Kwek Yong, director and head of wealth management at financial advisory firm Promiseland Independent. Also, because of the institutional size of the fund, fund managers may be able to make certain investments that are not accessible to the retail investors, Wong adds.
This story appears in The Edge Singapore (Issue 871, week of Mar 4) which is on sale now. Subscribe here
