I have always been a believer in “what happens over there is going to happen over here”.
With capital markets experiencing high volatility, I have taken the opportunity to dial into the US REIT results season, which has been very insightful and a reminder of just how large and investor-friendly the US sector is.
Scale, liquidity and focus are impressive. There are around 30 market-leading -specialist REITs with market caps over $10bn (£7.3bn), and many over $20bn.
Disclosure is excellent and the quality of management high, both operationally and financially. A lot of Q&A in the results season has been directed at capital markets and their potential impact, and on all the results calls management have demonstrated how Wall Street-savvy they are.
With a mature REIT sector one would expect a high degree of focus on funds from operations (a recurring cashflow measure) but the general level of detail and the guidance to investors is outstanding.
While in the UK and Europe we have made great strides over the past 20 years, thanks in part to the role of EPRA, there is still work to be done to create a large, liquid, investor-friendly sector with market-leading management.
So what are the key messages from the US results season?
Most companies reported good outlooks for their operations based on positive (although in many cases moderated) GDP and employment growth estimates.
There is considerable focus on tech demand and whether this is sustainable; for example, Prologis described the Bay Area in San Francisco as “stretched” but others, such as Boston Properties, a major office REIT, and Alexandria, a major business park REIT, reconfirmed that tech demand currently remains robust.
Energy and financial services demand may weaken, but generally the outlook on leasing and the prospects for development pipelines remain positive.
Two sectors in particular stand out in terms of strong fundamentals – logistics and multi-family/PRS. Prologis described the very positive impact of e-commerce not just on retail logistics demand but on wider industrial sectors, and Avalon Bay spoke about the growing demand from 35- to 45-year-olds for quality rental housing.
Sovereign wealth fund demand for property in the US is weakening, but this is being replaced by strong domestic institutional demand for quality assets. There have been a lot of questions on more “value add” or “transitional” assets. The majority view is that cap rates on secondary may well drift out.
Most REITs reported strong development pipelines with attractive expected yields on cost (most in the 6% to 8% range) and that returns on development are still materially better than for vanilla investments, although some REITs are bringing forward lease negotiations in order to de-risk potential vacancy. Only one major US REIT, Vornado, described its strategy as “buttoned down” with significant liquidity ($4.5bn) and able to take advantage of opportunities starting to appear.
There has been considerable debate over the “arbitrage” between weak equity markets and strong property markets, and questions have been put to management teams as to whether this could result in a change of strategy and selling assets in order to buy back their own shares.
Most companies indicated no change in strategy but it is clear that this is high on the agenda. Some REITs have a dilemma as to whether to continue with large development programmes when there is such value in the shares. Host Marriott has taken the lead with more than $1bn of asset sales and over $1bn of capital returned to shareholders, with further returns expected in 2016.
Finally, a word on the mall sector. What was striking from both Simon Property Group and General Growth Properties is how solid these businesses present against other sectors which are potentially more exposed to volatility in capital markets.
The falling oil price was not a focus of discussion but surely is a very positive contributor. Both companies are embracing technology and the impact of the internet and this, combined with intense analysis, drives their capital recycling – selling lower-performing assets and reinvesting in accretive pipelines.
This neatly brings me to Unibail, the European mall leader, which is ahead of its European peers in publishing results. Unibail stands alongside the very best US REITs as truly world-class in operations and finance, and continues to set the standard this side of the pond.
Robert Fowlds is head of Robert Fowlds Consulting
