Global Real Estate Investment Trusts underperform both equities and the S&P 500

MARKET REVIEW – GLOBAL

Global REITs (as per EPRA/NAREIT Developed Rental Index, USD) closed the month -2.4% in the red, underperforming both the global Equites (MSCI World Index) and the S&P 500 that delivered 59bps and 57bps for the month, respectively. US 10-year Treasury yields went from 2.86% at the start of the month and closed the month 20bps higher at 3.06% as the FED signalled a continued increase in the Fed Funds Rate over the next two years.

US consumer confidence rose to 138.4 points (close to the all-time high of 144.7 in 2000) which may lead to improved sales performance of mall and shopping centre REITs. Further, ISM non-manufacturing PMI unexpectedly rose to a near record 61.6% (from 58.5%) in September. In August CPI rose to 2.7% from 2.9% in July with core CPI (excludes food and energy) rising 2.2% and the Fed’s main measure PCE remaining flat a 2.0%. In addition, the US added 121 000 jobs (vs. 180 000 expected) with unemployment falling to a 49 year low of 3.7%. Average hourly wages met expectations by rising 2.8% y/y. Given the strong macro-economic backdrop and tighter labour market the FOMC expectedly hiked rates by 25bps in September. Interestingly the committee dropped previously constant statement; “the stance of monetary policy remains accommodative” which we have become accustomed to see in the press release. Fed chair Jerome Powell also stated that he expected one more hike in 2018 and three in 2019 with GDP estimates being increased from 2.8% to 3.1% for this year. A far larger issue last month has been Italian bond yields rising to a 4 year high of 3.6% (from 2.68% at 30 June 2018) due to Italy’s government proposing to raise its budget deficit to 2.4%, against EU fiscal limits and subject to full review on 15 October. The outcome of the proposal has implications for Italy’s sovereign debt rating and in turn the EU’s ability to subsidise or guarantee more of its members – another euro debt crisis could be on the cards.

Last month we saw European retail REITs report performance numbers with headliner Unibail-Rodamco-Westfield (now URW) meeting guidance at 6.8% but disappointing with their 6.4% growth outlook versus an expected 6-8%. The US portfolio also underperformed US mall peers in key metrics across the board. Institutional property asset manager Brookfield made an initial advance for UK mall REIT Intu, sending the share price up to 30% higher on the day. This may be the ‘white-night’ Intu and the UK mall sector needs in this difficult environment. As negative sentiment started to turn positive in the US retail environment, in turn mall / strip centre space, Mattress Firm (linked to Steinhoff) with 3 300 stores across the US filed for bankruptcy in September. Furthermore, as we write this, 125-year old department store Sears with 506 outlets is expected to file for Chapter 11 bankruptcy as they failed to rollover a seemingly paltry US$134 million in debt obligations. This will likely have a second-round negative effect on the mall space via the possible rent reductions to ensure and shadow vacancies created as Sears vacates unprofitable spaces.

After the massive move in the US 10-year bonds, global REITs are back in negative territory in USD terms thus showing more value than before. At a 4.3% forward dividend yield and 6-7% earnings or FFO growth over the next 2 years we see value in the sector. We also see convergence in REIT earnings as compared to general equities into 2019. The key risk is the US bond yield and how much it overshoots expectations in the mid term but we remain comfortable with our outlook for 7-9% total returns per annum over the next 2 years.