By Tyler Wilton, DWS
It wasn’t a great start to 2018 for the global property market, as stocks in this sector underperformed relative to broad equities—as represented by the MSCI World Index—for the first part of the year. Rising interest rates were likely the primary culprit, but the space has shown signs of stabilization going forward. There are a number of reasons for this shift, including solid earnings, increased merger and acquisition activity, and an overall move toward defensive segments of the equity market by some investors.
Stable property market supply and demand conditions should continue to support ample cash flow growth and limit downside to rental rates, while mergers and share buybacks should provide additional share price support. Private real estate pricing should be steady as a sizable backlog of allocated capital remains to be invested.
Income in Focus
Income potential is a key reason why many investors look to the real estate market, and investors have witnessed a rise in yields for one of real estate’s main competitors in the yield world, bonds. Still, even though bond yields have risen in 2018, the dividend yield spread remains attractive and stable for global real estate compared to global bonds, with recent readings of, respectively, 4.03% and 2.04%, suggesting that real estate is still a compelling income destination (Asset classes: global real estate = FTSE EPRA/NAREIT Developed Index; global bonds = Barclays Global Aggregate Index; global equities. Sources: DWS, Bloomberg. As of August 31, 2018.).
Why now?
We believe that, relative to broader equity markets, now could be an attractive entry point for investors to consider adding to their U.S. or global real estate position. In addition to the improving backdrop for real estate investing, a basic relative value analysis may support this opinion as well. In the charts below, we depict the relative price multiple of real estate compared to broader equity markets, where both U.S. and global property markets are near or below -1 standard deviation from the long-term average. For both relative price charts, global real estate is trading at a favorable level compared to historical readings: (Past performance is not indicative of future results. US REITs = EPRA NAREIT US Index; US Equities = S&P 500 Index; Global Real Estate = FTSE EPRA/NAREIT Developed Index; Global Equities = MSCI World Index. Source: DWS, Bloomberg. As of August 31, 2018.).
Adding Real Estate Exposure
Global real estate equities appear generally undervalued relative to broader equities and bonds. While subject to interest rate risk, strong underlying property and company fundamentals underpin cash flow growth going forward. While broader sector level themes may influence regional property market performance, we believe stock selection will be the key driver going forward in this market.
From an asset allocation perspective, real estate has, historically, outperformed broader equities as the yield curve flattens, supporting real estate investment trusts (REITs) as possible “investments” as bond spreads tighten. We believe REITs are poised to outperform other asset classes over the next several years, and now may be the time to consider increasing or adding to listed real estate in a diversified portfolio.
Bottom Line
REITs are a unique and growing asset class that continues to garner attention from the investment community for multiple reasons. The benefits of strategically allocating to listed real estate remain unchanged as REITs can offer diversification potential due to low correlations to other asset classes, stable dividends, and a possible hedge to rising inflation.
Add in the current trends, and it may potentially be an excellent time to jump into the market. This may be especially true for those willing to combine the recent market trends with the potential benefits of active management in this space. This mix could give investors a potent combination for gaining exposure to this often overlooked area of the equity world, at least if strong fundamentals hold into the future.
Learn more about our approach in the real estate market by visiting our real assets investing center.
This article was written by Tyler Wilton, CFA, Investment Specialists for Liquid Real Assets at DWS.