It has been a difficult few months for equity markets, not least North American real estate investment trusts (REITs), which suffered a two-month loss of -8.4%*. Investors’ retreat from property securities was undoubtedly triggered by signals from the US Federal Reserve (Fed) from May that it could potentially reduce (‘taper’) its monthly US$85bn asset purchase programme. At June’s Federal Open Market Committee meeting the Fed said tapering might begin later this year, and asset purchases could possibly end by mid-2014.
While the bumpy ride in the North American markets has reminded investors of the pitfalls associated with the road back from quantitative easing (QE), we feel a little perspective is in order. North American real estate equities have still returned 8.5% year to date ** and this follows several strong years for performance. The recent sell-down has been accompanied by a subsequent rally, indicating that what we witnessed was perhaps more of a knee-jerk reaction to the policy announcement, and gave some market participants an excuse to book profits.
In the short term, volatility is likely to persist as the Fed provides more clarification about what it defines as ‘economic improvement’. But the parameters for adjusting its monthly asset purchases should hopefully become clearer. While the impact to growth of the US budget ‘sequester’ (cuts to federal spending) has been dampened by ultra-loose policy, slow underlying growth is nevertheless still growth. A steeper yield curve is a sign that the economy is improving and that market relationships are normalising. That said, we believe that the Fed will tread cautiously this year and that tapering will be moderate, with greater emphasis in 2014. Similarly, we do not expect the subsequent increase in the Federal funds rate to occur until 2015. Inflation expectations appear to have stabilised, so we do not believe that tapering will have a significant impact on the long end of the yield curve.
We are currently positive on the US real estate sector from a fundamental perspective. Limited supply and generally lowly-levered balance sheets should help underpin earnings and drive dividend growth over the next two years. We expect earnings growth in the region of 7-10% in 2013 and 2014 and dividend growth that could exceed 10%. From a valuation perspective, we are fairly comfortable as US property stocks are trading at or slightly below net asset value using reasonable income projections. Average property yields still show an above-average gap over US ten-year treasury yields of 3.5%, which provides a reasonable cushion if bond yields begin to rise again.
At the sector level, the regional mall sector continues to see increasingly positive trends in same-store sales growth. The apartment sector also continues to experience rental growth, despite signs that the residential recovery is gaining momentum ***. Looking at the self storage sector, we believe that the recent underperformance from NYSE-listed Public Storage does not reflect the segment’s underlying fundamentals and the potential for rental growth given that occupancy rates are at all-time highs.
We have increased our allocation to North America within the Henderson Horizon Global Property Equities Fund in recent weeks and are currently 4% overweight, with the region now accounting for 56% of the fund’s exposure.
An update from Guy Barnard and Harrison Street Securities
* FTSE EPRA NAREIT North America Total Return Index in US dollars, 30 April to 30 June 2013
** FTSE EPRA NAREIT North America Total Return Index in US dollars, as at 14 July 2013
*** ie, rental growth in the apartment sector is sometimes the consequence of falling home ownership