By Eric Franco
Real estate stocks have now rebounded from the crash during the
global financial crisis. But we think valuations are still
reasonable, especially as property fundamentals continue to improve
in key markets.
Since bottoming in early March 2009, global real estate stocks,
as measured by the FTSE EPRA/NAREIT Developed Index, have performed
strongly, recovering nearly all the losses suffered during the
financial crisis. Now, many investors are asking whether global
real estate stocks remain a worthwhile investment. We think the
answer is yes.
While global real estate stocks may look pricier than other
equities, valuations have only just recovered to levels that are
average relative to their own history and they are still attractive
when compared with bonds. For example, the cash-flow yield spread
to 10-year government bonds remains well above normal.
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The picture is brighter outside the US. Valuations of US real
estate stocks are somewhat rich relative to their own history, but
stocks remain attractive relative to bonds. Outside the US,
however, real estate stocks still trade below their historical
average and also look very appealing versus bonds.
These valuations are underpinned by two key trends. First, both
debt and equity financing are relatively accessible and
inexpensive. Second, despite ongoing macroeconomic volatility, real
estate fundamentals are generally resilient or improving across the
world, from the Pacific Rim to Latin America.
In Asia, improving economic conditions are bolstering the
property markets. In Japan, the office market is showing initial
signs of a recovery in rents and vacancy rates after a prolonged
downturn. Liquidity remains abundant in other developed economies
such as Singapore and Hong Kong. Even in China, where the
government has recently taken cooling measures, we think the real
estate market is
less vulnerable to tightening
than widely perceived.
Europe remains a weak spot. While property demand is still
challenged, supply has been constrained for many years. Few public
companies are developing properties, which should support occupancy
rates and pricing.
In the US, most segments of the property market are performing
well. Many retail shopping centers are benefiting from improving
rents, and occupancy levels are now close to those of the previous
cyclical peak. Among the more economically sensitive lodging
stocks, occupancy in many markets has also recovered, which should
lead to ongoing increases in revenue per available room.
While the recovery in asset values has been more pronounced in
US coastal urban areas, it's now spreading to secondary and
suburban markets. This is being driven by higher prices (and hence
lower investment yields) of property in coastal urban markets and a
further loosening of debt markets. Against this backdrop, US real
estate buyers are going to the suburbs to hunt for higher-yielding
South of the border, public real estate stocks in Mexico are
also worth a look. In the retail and office market, a consolidation
of ownership is likely to drive property prices higher.
For investors, global real estate stocks offer a good way to
capture these trends in an asset that provides diversification
benefits to both stocks and bonds. Since many of these stocks are
structured as real estate investment trusts (REITs), they're
required to distribute most of their earnings as dividends,
providing a solid source of income. It's true that dividend yields
have fallen as stock prices have increased in recent years. But as
profitability in property markets continues to improve, real estate
stocks remain a good option for investors seeking income-producing
investments in today's low bond yield world.
Eric Franco is Senior Portfolio Manager-Global Real Estate
Strategies at AllianceBernstein.
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