After a five-year boom in property, particularly residential property, in the US, recent statistics ...
After a five-year boom in property, particularly residential property, in the US, recent statistics suggest the market may have passed its peak. Property companies in the US have traditionally traded at a discount to their net asset value but, after having eclipsed most equities in recent years (with an annualised 19.3% gain in dollars in the five years to end-March), US Reit funds were recently trading above NAV.
In this context, the pullback in the performance of Reit funds in the first quarter of 2005 was not entirely unexpected. And with increased sensitivity to interest rate fluctuations in the US, it is difficult to see where support will come from in the short term. There are further headwinds in the form of the Fed's determination to keep inflation in check by raising interest rates. This will cool the economy and could especially hurt Reit companies that borrow to finance their projects.
Yet, although property markets in several regions may be vulnerable to a downturn in economic growth, underlying fundamentals for Reits remain appealing, irrespective of short-term pullbacks. A large part of this appeal stems from the fact that the Reits business model is based largely on the value of tangible and quantifiable assets, namely large-scale commercial real estate.
Also, while there may well be a bubble in some home property markets in the US, these are not the kinds of assets that Reits typically buy.
The portfolios of most US Reits consist of occupied shopping centres, hotels and apartment buildings that produce consistent income. This income comes from rents paid to the owners of properties whose tenants often sign leases for long periods of time or from interest from the financing of those properties. Most of the income from these portfolios is paid out in the form of dividends.
Historically, the market for Reits has gone through long cycles of about 10 years. The last time there was a correction was in the wake of the dotcom bust, when overheated property markets were hurt in places like San Francisco, Munich and the Netherlands. Previous to that, there had been a correction in the early 1990s in the wake of the Savings & Loans crisis in the US but the market has clearly grown more disciplined and sophisticated since then. About two-thirds of US Reits are rated investment grade, not least because of their moderate financial leverage. In fact, their average debt ratio has generally been below 50% over the past decade.
Reit structures have quickly spread around the world in recent years. Australia and the US remain the largest markets but capitalisation growth at the rate seen in both those countries is expected elsewhere in the years ahead, in tandem with potential growth in market listings for real estate vehicles.
Real estate is the world's single largest source of financial wealth, with a 1998 survey by Ibbotson Associates suggesting the 48% of global wealth is invested in property, compared with 27% in bonds and 19% in equities. Yet, despite its recent and potential growth, Reits remain underexploited as a separate asset class, with Reit structures still only existent in 10 countries (US, Australia, South Africa, Canada, the Netherlands, France, Japan, South Korea, New Zealand and Singapore). What makes Reits attractive in these countries is that their very structure requires that income generated be passed on to investors in the form of dividends.
Listed properties have grown to over 70% of total available real estate in Australia, along with growth in private pension funds. This trend could be repeated elsewhere. Reit structures are expected to be launched in 2005/06 in the UK, Germany, China, Sweden, Italy, Thailand and Hong Kong.
We are very upbeat in our assessment of the Reit market in various parts of Asia. Demand is huge in Singapore, for example. The property market there has been through a difficult period, especially the market for industrial property. Japan is now beginning to recover from 16 years of property market decline. Economic growth is picking up and banks have cleared many distressed loans. There is more confidence in the market and rental rates have begun to pick up.
Reits are particularly attractive to Japanese investors because of the low rates paid on bank accounts. The property market in Hong Kong has also picked up over the past 12 months, with a noticeable recovery in average office rentals. Meanwhile, China is something of a mixed bag. It has experienced shorter property cycles but there are opportunities there for those who tread carefully.
Australia is one of the most closely followed markets. The property market there has performed well in recent years, but there has been some decline in real estate prices in the face of successive interest rate increases.
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