REITs: Liquid exposure to concrete gold with high yield sensitivity
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REITs: Liquid exposure to
concrete gold with high yield
sensitivity
DR BERND MEYER ULRICH URBAHN MAX KETTNER
CFA – HEAD OF CROSS CFA, SENIOR CROSS CROSS ASSET
ASSET STRATEGY ASSET STRATEGIST STRATEGIST
dr.bernd.meyer@ ulrich.urbahn@ max.kettner@
commerzbank.com commerzbank.com commerzbank.com
REITs (Real Estate Investment Trusts) provide an easy and liquid way to gain exposure to
another real asset – concrete gold – which unlike other real assets generates an income
stream. Fuelled by the hunt for yield, REITs were the best asset class in 2014, as safe-
haven yields slid into uncharted territory. In early 2015, they performed strongly, but have
underperformed recently as global bond yields rebounded. Here, we introduce Emerging
Markets (EM) REITs and look at which global regions and sectors are relatively attractive
on valuation and less yield sensitive, as we believe further differentiation is needed in the
run-up to the first Fed rate hike.
• PAGE 2: REITS – THE EASY WAY TO INVEST IN PROPERTY MARKETS
• PAGE 2: REITS WERE FUELLED BY THE HUNT FOR YIELD IN 2014 AND EARLY 2015
• PAGE 3: REITS SECTORS AND EM REITS
• PAGE 3: SHOULD A FED RATE HIKE BE FEARED?
• PAGE 5: YIELD SENSITIVITY AND VALUATION OF REITS REGIONS AND SECTORS
• PAGE 6: DISCLAIMER AND CONTACTS
1
REITS – THE EASY WAY TO INVEST IN Chart 1: REITs outperformance versus equities depends
PROPERTY MARKETS heavily on yield development
REITs are an easy, transparent, liquid and tax-efficient way to
Relative performance of DM REITs versus DM equities and 10-year US Treasury yields
invest in global property markets. They are companies that own 1.30 1.2
and let properties, and fulfil certain legal requirements, ensuring 1.25
1.20 1.7
the bulk of their business activity is property lending and that
1.15
at least 90% of the net income is distributed in the form of 1.10
2.2
dividends. REITs have traditionally been the focus of ‘yield- 1.05
2.7
1.00
hungry’ investors, given their high and stable dividend yield,
0.95 3.2
that is still in excess of the global equity dividend yield and 0.90
Treasury yields. In addition, REITs tend to apply higher financial 0.85 3.7
2011 2012 2013 2014 2015
leverage than equities. For these reasons, they are more
— Ratio: REITs /Equities — 10-year Treasury yield (percent, inverted, right axis)
sensitive to changes in bond yields (see Chart 1). REITs usually
enjoy special tax status, with little to no requirement to pay Source: Bloomberg, Commerzbank Research
taxes at the company level. The combination of tax efficiency
and high liquidity is not found in other forms of real estate
investment, making REITs an excellent choice for investors Chart 2: REITs no longer over-deliver compared with our
looking to invest in another real asset, namely property, or model-implied return
concrete gold.
REITs no longer over-deliver compared with our model-implied return
80
REITS WERE FUELLED BY THE HUNT FOR YIELD 60
IN 2014 AND EARLY 2015 40
In 2014, REITs were the best asset class and considerably 20
0
outperformed equities. This development was mainly driven
-20
by falling interest rates and the global hunt for yield, which -40
were supportive of REITs due to their high financial leverage -60
-0.8pp gap between realised and
estimated performance
and high dividend yield (see Chart 1). In early 2014, we had -80
1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013
expected REITs to fare well that year, as they had substantially
— Realised 12-month return — Estimated 12-month return
underperformed our model-implied return in 2013 (see Chart 2).
However, the strength of the run surprised everyone. Developed Source: Bloomberg, Commerzbank Research, as at 30/04/2015
Markets (DM) REITs outperformed equities by 10.4 percentage
points (pp) in 2014, with all regions, apart from Japan,
outperforming their respective equity markets. UK REITs were
the strongest outperformer with almost 20pp outperformance
versus the blue-chip stocks. In absolute terms, US and Europe ex
UK REITs exhibited the strongest performance.
This meant that REITs not only closed the gap between the
model-implied and the actual return but markedly over-delivered.
By the end of January 2015, we found that REITs exceeded the
model-implied return by 17.7pp over the previous 12 months.
In turn, we became more cautious and halved the overweight
of REITs in our Cross Asset Portfolio at the beginning of
February. Since then, REITs have underperformed equities
as safe-haven bond yields backed up. This roller-coaster ride
also resulted in a similar scenario for the relative performance
“Falling interest rates and the global hunt for yield were supportive of REITs, due to
their high financial leverage and high-dividend yield”
2of REITs versus equities (see Chart 1). As a result, REITs have Table 1: Sector mix is heterogeneous across regions –
now underperformed equities since the start of the year. US REITs much more balanced than non-US REITs,
where diversified REITs dominate
By region, only UK REITs have outperformed their respective Weight matrix of different REITs regions and sectors, percent
equity peers since the start of the year. In particular, Japan, Hong
United Europe
Kong and US REITs have underperformed their equity markets States (incl UK) UK Asia DM
quite considerably year-to-date. Diversified 8.2 40.0 54.6 56.9 27.7
Healthcare 13.5 0.5 1.3 na 7.4
REITS SECTORS AND EM REITS
Industrial 4.5 3.4 7.5 8.2 5.4
Table 1 shows that the largest weight in the DM REITs universe
Industrial/
belongs to the diversified sector, followed by the retail sector, 2.8 na na 1.5 1.9
Office
which together account for more than 50% of the index. US
Resorts 7.9 na na 0.7 4.4
REITs are much more balanced than non-US regions, which
Office 12.6 9.4 7.6 12.0 11.9
largely consist of diversified REITs. The sector mix is important
Residential 16.6 14.7 3.5 1.7 12.1
for investors, as each sector has distinct features and therefore
exhibits differing sensitivity to changes in interest rates. Retail 27.6 30.9 22.6 18.9 25.8
Self Storage 6.3 1.1 2.8 na 3.5
For emerging markets, the EM REITs Index began in December Developed
56.3 15.4 6.0 28.3 100.0
2008. It comprises 154 REITs with a total market cap of roughly markets
USD149bn, which compares with 312 REITs and a market Source: EPRA/NAREIT, Commerzbank Research, as at 18/02/2015
cap of USD1.3trn for DM REITs. Apart from the smaller size,
the EM universe is also much more concentrated: the top
ten constituents account for more than 35% of the market Chart 3: EM REITs universe tilted towards Asia Pacific and
capitalisation, while in the DM index this figure is just 22%. in particular China
Index weights in EM REITs index, percent
The EM REITs universe is tilted towards EM Asia Pacific,
EM REITs EM Equities
much like the regional structure of EM equities (see Chart 3).
A closer look reveals that Chinese REITs are by far the largest 20.8% 60.6%
15.5%
67.3%
weight within this sub-index, and account for roughly 36%
17.2%
of the overall EM index, followed by South Africa (13%) and
4.9%
the Philippines (8%). In terms of sector structure, the bulk of
EM REITs are in the diversified (65%), residential (22%) and
13.7%
retail (10%) sectors.
EM REITs have been underperforming DM REITs consistently
EM Asia Pacific EM Europe EM Asia LatAm
in the past few years. This is in line with EM equities EM LatAm EM Mea EMEA
underperforming DM equities during the same period,
Breakdown of 60.6 percent EM REITs, EM Asia Pacific, percent
although there was a slight rebound of EM assets in recent 59.8
60
weeks due to the likely delay of the Fed lift-off. However, there
are considerable differences in terms of performance within EM
40
REITs: LatAm and EM Europe, particularly, have performed poorly,
while EM MEA and EM Asia Pacific have been outperforming, with
20
EM MEA REITs outperforming DM REITs. 12.2
9.5 8.1 7.3
3.0
0
SHOULD A FED RATE HIKE BE FEARED? China Philippines Indonesia Malaysia Thailand Other
Historically, REITs have weathered the start of central bank
rate hike cycles relatively well, but their relative performance Source: Bloomberg, Commerzbank Research, as at 13/02/2015
to equities shows considerable volatility. Given this, we are not
sceptical about REITs per se, only because the Fed is expected
to start tightening this year.
Moreover, we discovered a shift in how the relative performance
of REITs versus equities is related to the yield development.
3What has changed in recent years is that REITs do not seem
to be related as much to front-end yields as to long-end yields. “The EM REITs universe is tilted towards
Why is this? For one, the impact of rising yields on the EM Asia Pacific, much like the regional
refinancing of REITs was previously a focus, resulting in a
stronger sensitivity to the maturities at which the re-financing structure of EM equities”
happens: the shorter to middle part of the yield curve. With
the hunt for yield kicking in, the main impact no longer came
from refinancing but from the level of the REITs dividend yield
compared with the yields of other assets. REITs compete with
the highest yielding bonds (ie the ultra-long end of the curve),
raising the sensitivity of ultra-long-term yields to the relative
performance of REITs versus equities.
In addition, increased sensitivity to long-end yields was, at
least, partly because the visible bull-flattening meant that
strongly declining long-end yields were coinciding with rising or
unchanged short-term yields. Our model-based return estimates
incorporate the slope of the yield curve as an explanatory factor.
We have shown in the past that REITs returns depend negatively
on the development of the curve, and a flattening of the yield
curve tends to be positive for REITs.
Our economists expect the US lift-off will not occur until
September 2015 at the earliest. However, they have also adjusted
the expected path of monetary tightening and anticipate rather
4“We believe Fed rate hike uncertainty necessitates more differentiation in REITs”
gradual upward moves for Fed fund rates. Therefore, we believe Chart 4: Asian REITs ex Japan look attractive...
the long-end of the Treasury curve will remain relatively immune
to Fed rate hikes and, going forward, any underperformance of 4
Attractive
REITs versus equities should not be pronounced. EM 3
UK Asia Pacific
Europe 2 excluding Japan
excluding UK EM Hong
YIELD SENSITIVITY AND VALUATION OF REITS
Valuation Score
1 Kong
REGIONS AND SECTORS 0
UK
Charts 4 and 5 show our relative valuation and rate-sensitivity US -1 Japan
scoring models. This scoring model is based on six different Europe
excluding UK -2
valuation measures (eg P/E ratio, dividend yield) in order to
US -3
detect relative attractiveness on valuation grounds. For yield
-4
sensitivity, we incorporate four different leverage ratios, as Vulnerable
-5 Japan
well as historical correlations and sensitivities to yield changes. -6 -4 -2 0 2 4 6
The regional scoring model differentiates between relative Debt & Rate Sensitivity Score
valuation based on current levels and relative valuation based ■ Relative valuation based on current levels and relative rate sensitivity
■ Relative valuation based on valuation compared to history and relative rate sensitivity
on valuation compared to history. The difference between the
former and the latter illustrates that part of the regional valuation Source: Bloomberg, Commerzbank Research, as at 05/05/2015
divergence on current levels is structural, eg different sector
structures. However, this message remains similar.
Chart 5: ... as well as industrial and diversified REITs
Our scoring model shows that Asia Pacific ex Japan, in particular,
Retail 4 Industrial/Office
as well as Hong Kong, look attractive and should weather a Attractive
potential US rate hike fairly well as their valuation and rate
sensitivity is relatively favourable. In contrast, the US looks to 2 Industrial
be the most vulnerable. The residential, healthcare and office
Valuation Score
Diversified Resorts
sectors seem to be more vulnerable due to their negative 0
valuation and rate sensitivity scores. In contrast, industrial
and diversified REITs look more attractive in terms of valuation Healthcare Office
-2
and rate sensitivity. Residential
Vulnerable
-4
-6 -4 -2 0 2 4 6
Debt & Rate Sensitivity Score
■ Relative valuation based on current levels and relative rate sensitivity
Source: Bloomberg, Commerzbank Research, as at 05/05/2015
SUMMARY
REITs are an easy, liquid and tax-efficient way to invest in another real asset: concrete gold. DM REITs were the best-
performing asset class in 2014 and continued this strong run in early 2015. Since then, they underperformed equities as
safe-haven bond yields stabilised and rebounded. Given the generally higher yield sensitivity of REITs than equities, we
believe that Fed rate hike uncertainty necessitates more differentiation in REITs going forward. In terms of their relative
valuation and rate sensitivity, we find Asian REITs, bar Japan, look attractive while US REITs seem more vulnerable.
Among sectors, industrial and diversified REITs are less yield sensitive and more attractively valued.
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