SPECIAL REPORT: Listed sector bounces back, but why?

The strong performance of Europe’s listed property sector this year compared to 2018 even has some experts scratching their heads. Dominic Gover investigates the possible reasons behind the rebound. 

Depending on which relevant composite index or measurement is observed, total returns from European public property companies including REITs are up between 9-10% in the year to date, compared to a decline of 4% across the past 12 months. Meanwhile, in the US, public property companies have performed even better, with returns of 19.1% over the first seven months of 2019. 

This is good news for investors with shares in a basket of companies. But at the same time, it has raised a deceptively tricky question: why have returns been so good when they were falling in parts of 2018?

The factors underpinning the strong positive total returns – which are made up of both share price rises and dividend payments – range from solid underlying real estate fundamentals to strong demand for real estate as an asset class. Some real estate professionals wonder whether there has been a correction or an over-reaction to the downside in 2018. Others focus on the continuing trend of lower interest rates. Another possible explanation is good old-fashioned improvements in underlying real estate fundamentals.

Egbert Nijmeijer, co-head of real estate at Dutch merchant bank Kempen & Co, observes that this year’s strong performance is in sharp contrast to Q4 2018. In the final quarter of last year, the performance of European REITs dipped 15-20%, resulting in the likes of French property company Gecina trading at eye-catching discounts to the net asset value of its property portfolio.

Nijmeijer notes the dip in performance last year and comeback in 2019 could have something to do with capital outflows in Japan. ‘The main reason was that the asset management industry had to cope with a lot of outflow [in Q4 2018]. Mostly it was Japanese investors pulling money from REIT funds for technical allocation reasons and that put pressure on the REITs because the flow was big, and in November-December the trading got thinner and thinner,’ he says.

In his opinion, many people then returned from holiday in January and saw Gecina was ‘cheap and high quality’, so decided to buy its stock on the cheap, leading to a very strong Q1 during which share prices went up 20%.

Bonds and interest rates
While experts such as Nijmeijer factor in issues such as a Japanese pullback at the end of 2018, traditional analysis of the performance of public property companies involves examination of a correlation with the wider equities markets. Also in the mix would be how much capital is targeting real estate given alternatives in the bond markets, and the direction of travel of interest rates.

‘It has to do with falling interest rates and just a general view of opportunities in Europe,’ says Ronald Dickerman, president and founder of private equity firm Madison International Realty. ‘Real estate is quite pricey now, and maybe this has been reflected in the public markets. We have definitely seen a resurgence in stock prices and a narrowing of discounts.’

There are several different benchmarks that investors turn to when examining the performance of listed property companies. For a global comparison, there is the FTSE EPRA Nareit Global Real Estate Index Series, designed to represent general trends in real estate equities worldwide, and the FTSE EPRA Nareit Developed Index.

The FTSE EPRA Nareit Developed Europe Index is a subset of the latter. The entire basket represents companies with a total market cap of €226 bn. Its largest constituents are Germany residential company Vonovia, retail giant WFD Unibail-Rodamco, Deutsche Wohnen, Segro, Gecina, LEG Immobilien, and Land Securities. As an index, it is weighted 31% to diversified real estate, 25% to residential, 14% retail, 13% office, and 7% industrial.

Year-to-date, total returns of this index have been 10%, compared to -1.9% for the 12 months to 31 July.

Return data from other sources also show the rebound in performance of public property companies. Across Europe this year, total returns per country are up 5.9% in Germany, 6.7% in the UK, 19.1% in France,  20.1% in Austria, 21.2% in Spain, while in Sweden the increase is 27%, according to index provider Global Property Research (GPR).

 What is certainly continuing to make real estate an attractive option is the European Central Bank’s seemingly endless appetite for printing money. Last month, it elected to keep interest rates at 0% for as long as necessary. That means that although real estate is historically ‘expensive’ and yields are getting squeezed – for example in logistics, where yields have recently dropped to historic lows – listed real estate still offers a cash yield or a net rental income return considerably better than bonds.

Bond markets are going through historic times with negative yields and it seems reasonable to assume what is happening in this asset class would impact real estate equities positively. In such conditions, allocators look to equities and alternatives to juice up overall risk-adjusted and diversified returns. Real estate equities sit as almost a hybrid of equities and alternatives, another possible reason for the resurgence this year.

Strongest and weakest performers
Within this year’s turnaround there are winners, some big losers - and a mixed picture. For those who value clarity, there are contrasting facts to contend with, such as that the best and worst performing companies by total returns are both headquartered in the UK, according to figures from GPR. British logistics REIT Segro has performed strongest across all Europe, with total returns up 32.4%. Meanwhile, in last place in the entire continental sector is Intu, the beleaguered UK shopping centre operator. Its returns have nosedived 57.8% this year as the company has been hit by tenants’ failure to get to grips with the challenge of online shopping, which has in turn squeezed traditional revenue models. Meanwhile, fellow retail operator Hammerson is second bottom, with returns down 32.2% Elsewhere, Swedish residential property managers, Fastighets AB Balder, (returns up 31.8%) and Hemfosa Fastigheter (up 28.6%) are the second and fifth-best performers in Europe by total returns – underlining Sweden’s status as a safe haven.

Despite this patchiness, some believe more growth can be expected. The European Public Real Estate (EPRA), which represents the sector, unsurprisingly talks up its prospects.

‘There is still room to grow for the European listed sector,’ insists Barney Coleman, EPRA’s operating director. ‘There are a number of factors that make us confident that this will happen. One is the strong and stable dividend yield, which is attractive to institutional investors. Historically, US pension funds have always favoured LRE [Listed Real Estate] more than their European counterparts, however in Europe we are starting to see this sentiment shift towards our sector.’

Research conducted by EPRA appears to bear this out. Looking at more than €2.6 tln of assets under management, the study found LRE to be one of the most cost-efficient asset classes in European pension fund portfolios - outperforming private equity.

‘We have also recently achieved the lowering of Solvency II capital requirements for insurance companies from 39% to 22%, allowing listed real estate assets to be treated the same as short-term equity holdings,’ Coleman continues. ‘Moreover, the recently adopted pan-European personal pension product regulations are set to unlock vast investment potential in the LRE sector, with a total €231 bn set to flood the European equities market, according to a study undertaken by EY.

‘Finally, large and accelerating investment flows into alternative property sectors, such as logistics, industrials, healthcare, hospitality and self-storage, are forecast to drive a doubling in the size of the benchmark FTSE EPRA Nareit Developed Europe listed real estate index, to around €500 bn within the next five years, from its current size of approximately €250 bn.

‘In the US, alternative real estate sectors already represent about 40% of the REIT market, compared with 10% in Europe. If European companies match the market share of their US peers, that would alone add 50% to the size of the European index,’ says Coleman.

‘Flawed’ NAV metrics
But the sector could be performing even better and investors are losing out on higher returns because of one bad habit, reckons international advisor Green Street.

It claims the practice of issuing company-reported NAVs is badly flawed because they are too infrequent and at risk of inertia, which hurts investment decisions by hampering insight and causing valuation errors. Differing ways of compiling NAVs across Europe compound the problem, Green Street says. Compiling spot NAVs more regularly and using a uniform method across borders could benefit returns – and of course the company offers this service.

Analyst Rob Virdee, said: ‘There is a lot of opportunity to do things better [in Europe].  Investors are anchored to company reported NAVs – and while these are valuable, they suffer from being backward looking which can lead to significant valuation error.’

EPRA’s Coleman admits a little bit of education in certain areas could help lift the sector.

‘It is true that often the listed sector is still overlooked by generalist investors. All our commissioned research shows that including listed real estate assets in the portfolio provides for greater long-term returns. Listed real estate is closely correlated to other forms of real estate. It takes about 18 months for an investment in listed real estate to shed the influence of the general equities market and to start mirroring the performance of the company’s underlying portfolio.

‘EPRA is working very closely together with generalist investors, both here in Europe and globally, to convince them and make them benefit from the listed sector’s long-term performance and dividend yield. We are conscious that it may take some time for those investors to increase their asset allocation to listed real estate, but even small shifts in sentiment can go a long way.’

To make its case, the organisation hosts events throughout the year, including large-scale corporate events or an ‘investors day’ at EPRA’s annual conference, taking place this year in Madrid, on 12 September.

Two challenged spots
Perhaps two of the biggest challenges facing the listed sector lie in the Berlin residential sector and the European retail industry.

From 2020 it will be forbidden by law to raise rents in the German capital by more than 50 cents per square metre, for five years. The planned rent freeze is being implemented to halt the march of gentrification, which critics say is making the city unaffordable, after rents rose by 50% since 2011. Pressure by citizens has led to the cap on rent increases by the local government, which is proving unpopular with investors facing diminished returns.

Germany has several listed residential landlords, including Vonovia, Deutsche Wohnen, LEG and TAG. Ado Properties, which listed on the SDAX market for small caps in 2015, is focused exclusively on Berlin with a €4.4 bn portfolio. It has seen its share price fall sharply in the past six months despite booking rental growth of 9.9%. Other relative newcomers to the stock exchange include Aroundtown, TLG, Adler and Grand City.

Secondly, retail property companies have major headwinds to deal with.

Big retail names have been under significant pressure for good reasons, such as ageing populations spending less on goods, oversupply, the rise of e-commerce creating greater convenience, price transparency and power of choice for consumers away from bricks-and-mortar locations. Lastly but certainly not least, too-high rents after years of outsized retail real estate returns, have made rents unaffordable for many low-margin retail tenants who have fallen into trouble.

Amid these troubles, the listed sector is even showing a way ahead for retail, believes EPRA.

‘Listed companies are providing a lead with innovation and by harnessing technology, which are at the forefront of all the listed retail companies, thanks to having a long-term horizon,’ says Coleman. ‘Retail has taken a hit over the last few years, but it is evolving and becoming more of an experience, drawing shoppers to malls for more than just a shopping trip. Old-fashioned retail might eventually disappear, but those companies who embrace change and provide consumers with reasons to use physical retail should thrive.

‘E-commerce penetration in Europe is increasing, but is still much lower than in North America. All of this means that there is less oversupply of retail space in Europe and therefore less likelihood of a major impact on European shopping centres.’

Future prospects
What about the prospect of something major derailing the listed sector’s current upwards trajectory in the near future? Kempen’s Nijmeijer suspects this would not emerge from the debt market, as the global financial crisis of a decade ago did. If it does, then quantitative easing by Europe’s Central Bank will be partly to blame.

‘The amount of equity available today is phenomenal, compared to past cycles when too much debt was available,’ says Nijmeijer. ‘That’s because of this money printing by central banks, so the issue this cycle will be on the equity side, and it is in these low-quality equity firms where the bubble could grow and then pop.

‘This is when you’ll see corrections and allocators will burn their fingers and the pendulum will swing back. But a recession has been forecast for the past two years and we’ve not seen it, despite Germany slowing down.’

Market watchers also point to the risk of a global economic slowdown - triggered by trade wars and events such as Brexit – filtering through to real estate and dampening the prospects for growth. Year-to-date growth for listed companies has been good, but incautious investors can still be vulnerable. Yes,  commercial real estate is stable, but it can also be extremely cyclical if the cap-rate increases and Net Asset Value drops.

‘We are currently forecasting a return of 8% with our global property strategy,’ Nijmeijer points out. ’That is big and you wouldn’t get this rate if the risk was lower.’

‘The fundamentals are still very healthy and interest rates are coming down which is the opposite of what people expected. As an asset class it’s extremely interesting. But at the same time you have to be careful what you invest in.’

Where did the IPOs go?
Fewer European real estate companies are going public, with the number of IPOs in 2019 plunging compared to previous years.

A mere four IPOs took place in the first seven months of this year, while seven have been either cancelled or postponed, EPRA data shows.

In contrast, there were eight IPOs in the first half of 2018 and 14 by the end of the year – itself a low volume by historical standards.

So, what is the reason for this year’s sluggishness?

Possible factors are difficulties the real estate sector is facing in the UK and Germany, which between them comprise 54% of the free float market – fully 21% and 33% respectively, according to Global Property Research.

The passage of Brexit from the ballot box to reality is causing uncertainty, with data from  adviser Savills showing UK real estate yields for July were at their weakest for three years.

Meanwhile, in Germany the housing rent freeze in Berlin threatens to squeeze returns for investors and many German residential firms have large exposure to the capital city.

The size of these two markets in the EU listed sector means that when they sneeze, the whole market gets a cold.

Then there is the malaise in the retail sector, another potential contributor to the absence of IPOs. Shopping centre operators such as Intu and Hammerson are experiencing falling rent revenues from tenants which are seeing online shopping take a large and growing share of shoppers’ spending.

Intu’s share price shows this starkly. At the end of July it was down at 47.85p, a vertiginous drop from 113.4p in January.

Other potential causes for the dearth of IPOs include a lack of appetite for investing on secondary stock exchanges and in so-called ‘blank cheque’ companies with no portfolio, which rely on an IPO to begin acquiring assets.

Macroeconomic factors cannot be ruled out either, such as loose monetary policy by the European Central Bank.

Egbert Nijmeijer of Kempen, said: ‘The popularity of private equity pulled most of the capital flow into that direction and less towards public real estate. When the pendulum swings back public real estate is likely to grow again through equity raises and IPOs.’

A lack of IPOs this year in the real estate sector highlights where sector growth is likely to come from in future, according to some analysis.

Barney Coleman, operations director at EPRA, said: ‘This again underlines the importance of the alternatives sector in driving growth. We are expecting to see more IPOs in the future based on the growth of residential and alternative sectors.’

Potential IPO activity in Q4 this year surrounds French REIT Apsys, German industrial developer Garbe International, and a possible demerger by British REIT, CapCo.


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