Uniplan REIT Outlook 2020
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Uniplan REIT Outlook 2020
REIT Outlook 2020
Overview
As we head into the Q4 earnings season, we took the opportunity to attend the
annual NAREIT REIT World Investor Conference in November. The following are
some key takeaways on the outlook for 2020 from the many one-on-one meetings
along with our outlook for 2020. We continue to have a generally positive view
toward the equity REIT sector, while recognizing that the current risk-on
environment could result in an equity market "melt-up", which could cause potential
relative performance headwinds for REITs during periods of 2020.
The combination of slowing economic growth, political uncertainty, and the
upcoming Presidential election when combined with the solid fundamentals
underpinning most REIT sectors will position the group to deliver attractive risk-
adjusted returns next year. From a supply and demand perspective, the U.S.
commercial and residential markets generally remain in balance and growing.
Additionally, property owners are benefiting from the rapid rise in replacement cost
inflation that has been trending at 2x-3x the rate of the approximately 2% CPI.
Still Offering Yield and Solid Earnings Growth Appeal
• 2020 Return expectations – We expect REITs will generate 7-9% total return in
2020, approximately half comprising a cash dividend yield of ~4%. REITs are on
track to generate over 20% total return in 2019. This is well ahead of our forecast of
5-7% a year ago as REIT valuations substantially improved with the Federal Reserve
cutting interest rates in 2019 rather than increasing them as we expected. In 2020,
we think the Fed will hold largely steady on rates and believe REITs will produce
earnings growth of 4-6%, pay an approximate 4% cash dividend, and the earnings
multiple will hold broadly steady.
• Earnings growth – Over 2020, we assume earnings growth for most REITs will be
largely driven by income increases from further solid space demand and limited new
supply. Most companies should be able to raise rents and maintain high portfolio
occupancy. Additionally, there should be incremental gains from acquisitions and
refinancing.
• Dividends – The REIT sector currently offers a dividend yield of ~3.5%, double
the yield of the S&P 500 Index. We believe REITs will grow their dividends by
mid-single digits in 2020, matching the pace of what we think their FFO/AFFOUniplan REIT Outlook 2020
growth will be. The value of the after-tax REIT dividends was boosted by 17%
from the 2017 Tax Cuts and Jobs Act for most shareholders.
• Fund Flow – REITs are on track to raise ~$100bn of capital in 2019 which would be
close to double the $55bn raised in 2018. Private Equity Real Estate funds continue
to attract elevated inflows and have considerable untapped money to spend. The
investment appeal of property investment looks likely to be solid through 2020.
• Principal Assumptions and Risks – We assume ~2.0% Y/Y US GDP growth in
2020 (weighted towards 2H) and largely unchanged interest rates. We regard the
major risks to sector stock performance to include an unexpected economic slow-
down which could sap space demand. An unexpected acceleration in the economy
might prompt an increase in interest rates which would be a headwind to REIT stock
performance. Future changes to the tax code might be a negative and could be a
point of concern going into the general election. Excessive new development, which
is commonly a cause of cyclical property risk, generally appears to be a low
probability at present.
Other REIT Factors
Earnings Growth Prospects - Most companies have reported solid Y/Y quarterly
growth in the mid-upper single digits of FFO/AFFO per share over the first three-
quarters of 2019 and we expect they will close out the year on a similar pace. Bottom
line growth has been largely driven by positive operational performance and prudent
balance sheet management. Most REITs have maintained high portfolio occupancy in
the mid 90%’s, which when combined with rental pricing power and expense control has
generated continued growth in NOI. We are several years into the expansionary part of
the cycle but yet there are only limited signs of headwinds emerging from an imbalance
of space supply exceeding demand. Assuming further steady growth in the economy
which will support further space demand, REITs should be able to deliver earnings
growth and higher dividends over the next year or two.
Company Earnings Guidance - A handful of companies have provided initial FY20
earnings guidance which generally has forecast a ‘same again’ operating environment
and should help deliver similar bottom-line growth outcomes to what we have seen to-
date in 2019. Most companies will provide FY20 earnings guidance with their 4Q/FY19
earnings in January and early February. We expect many will guide to Y/Y
earnings/operational growth largely consistent with the early guiders. Exceptions will be
those companies still rationalizing their portfolios by selling more assets than they are
buying and de-levering, most notably among Shopping Center and Healthcare REITs.
We anticipate in many cases that the scale of this activity and the associated earnings
drag to now be largely behind us.Uniplan REIT Outlook 2020 Dividend Growth – Most REITs have continued to increase their common dividend payments. The dividend coverage remains strong and earnings quality high. American Tower (AMT), the largest REIT by equity market capitalization, grew its dividend payment by 20% this year. Equinix (EQIX), the largest data center company, grew its dividend by 8%. Simon Property (SPG), the mall giant, has raised its dividend at an annual compound rate of over 10% over the last 5 years. Equity Lifestyles (ELS) has announced it will lift its payment by 12% Y/Y for 2020. We also need to mention Federal Realty (FRT) which raised its dividend 3% mid-year, marking its 52nd consecutive annual increase while Realty Income (O) has recently raised its distribution by 3.0% Y/Y, marking its 88th consecutive quarterly increase (that’s 22yrs) and its 584th unbroken dividend declaration (that’s closing in on 50 years). The value of after-tax REIT dividends was boosted by 17% for most shareholders from the 20% Pass-Through deduction included in the 2017 Tax Cuts and Jobs Act. We continue to believe the value of this tax reduction has yet to be fully comprehended by many investors. As investors consider their 2019 taxes with their advisers early in 2020, we believe this benefit may become better appreciated. Fund Flow – Institutional interest in real estate and REITs remains strong and appears likely to remain so in 2020. Many large institutional investors have target property allocations of 10-12% and are underinvested. Capital raised by REITs in 2019 through the end of October had totaled $88bn, putting the sector on track by YE to match the $100bn high point of funds raised in 2017. This year, funds have comprised $51bn of unsecured debt, $33bn of common equity and $4bn of preferred shares. Equity capital issuance has become more frequent as share prices/valuations have increased. We expect higher levels of equity issuance to persist should higher stock prices hold. Debt markets remain open at attractive terms, with many REITs able to tap long term (10 years and longer) unsecured corporate debt at sub-5% (even sub-4%) levels. In the whole loan mortgage market, similarly attractive rates prevail, and the Commercial Bankers Association YTD 3Q19 CRE/Multifamily mortgage originations were running 15% above the record YTD 3Q18 totals. There was some reduction in activity in Retail and Hotels but modest rises in all other categories – Multifamily, Office, Industrial, and Healthcare. Aside from the public REITs, institutional commitments into Private Equity Real Estate (PERE) funds continues to be robust. According to Preqin, PERE funds have raised $121bn (three-quarters ear-marked for North America) in 2019 through the end of September. For the FY18, PERE funds raised $124bn marking the sixth consecutive year of greater than $100bn of fundraising. These PERE funds currently have $300bn of ‘dry powder’ which, with 3x leverage, implies they have $900bn of spending power. Property investments look well underpinned given this available capital waiting in the wings to be deployed. New Development - Construction costs have been escalating at a 5%-10% annual rate due to rising labor and material costs. Furthermore, financing conditions have become more difficult for some REIT participants. Higher development costs curb new-build
Uniplan REIT Outlook 2020 activity and help lift the room for rent increases on existing properties before new supply can be economically justified. Mergers & Acquisitions - Private Equity property giants Blackstone (BX) and Brookfield (BAM) are flush with capital to deploy. In particular, BX has been active in 2019: it bought the Singapore based GLP industrial portfolio for $19bn and Colony Capital’s (CLNY) industrial assets for $6bn. The recent $4.25bn purchase of the Bellagio in Las Vegas was also a notable transaction. In the public-to-public arena, Prologis (PLD) has announced deals to acquire Industrial Property Trust (IPT) ($4bn) and most recently Liberty Properties (LPT) for $13bn. We expect M&A activity in the sector to continue but with many REITs currently trading at or close to NAV, they are generally less attractive to buyers as potential targets. We think activity will likely be concentrated more in ‘hot’ property types – industrial and tech- related – and potentially in the ‘cold areas’, where sizeable discounts on retail properties just might attract some contrarian attention or trigger some scale-related M&A. Capital Allocation – This has continued to be a big part of management/investor/analyst discussions. Many companies have been actively rationalizing their portfolios over recent times with reallocation decisions being more prominent. This has included discussion of acquisitions, development, debt reduction, dividend increases, and share issuance/buy-backs. We anticipate this will be a topic that will remain an important discussion point in 2020. Stock issuance has increased as REIT valuations have risen over the year. At-The- Market (ATM) and Forward deals have been popular. On share buy-backs, SL Green (SLG), the Manhattan office/retail owner, has bought back $2.0bn from a $2.5bn program, by selling assets and buying back stock at a discount while reducing debt with the proceeds. Stock price discounts to NAV’s of around 15% are a general valuation point of reference. At present, several retail stocks are trading at sizeable NAV discounts which has prompted some modest share buy-back activity. From a balance sheet perspective REITs appear solidly positioned with Net debt to EBITDA ratios of 5-6x, limited variable rate exposure and well laddered extended maturities. They are positioned to be more aggressive buyers should opportunities arise and are prepared to withstand higher rates and/or an economic slowdown in the short- medium term given current undrawn credit reserves on the collective REIT balance sheet. Leading Sub-sector Outlook Tech-Related – Towers & Data Centers (21% of NAREIT Equity Index) Many of the companies in these sub-sectors continue to exhibit premium growth of >50% above the sector average, fueled by strong user demand and accretive acquisitions. Investor enthusiasm for the towers is greater than demand for the more capital-intensive datacenters. Among the tower companies, American Tower (AMT) FY19 guidance is for
Uniplan REIT Outlook 2020 11% AFFO/sh growth and Crown Castle is guiding to 8% AFFO/sh growth this year and has provided initial guidance for 7% Y/Y growth in 2020. Equinix (EQIX), the largest data center company, is guiding to 9% AFFO/sh Y/Y growth. Residential (16%) - Apartment operational performance remains positive as tenant demand has remained strong and levels of new supply appear to have peaked in some markets. The Sunbelt and West Coast have been stronger than the Northeast. Several cities in California and New York City have recently adopted rent control laws, being less onerous in the former than the latter case. In Student Housing, new supply and pricing issues have weighed on operational performance though the longer-term outlook remains favorable. Single-Family rental housing has continued to post solid results with NOI growth running above apartment growth rates with per square foot rents below apartment levels. Retail (15%) – Many malls and shopping center companies reported high occupancy and releasing spreads of 5-10% notwithstanding heightened retailer bankruptcies. While the rise of e-commerce and the decline of department store and apparel sales continue to weigh heavily on investor’s minds, space demand for the quality properties in good locations has remained strong. The best-managed retailers continue to revamp their businesses to the ‘omni-channel’ world in which good bricks and mortar outlets play a valuable role. We continue to look at the overall strength of management and REIT balance sheets as key points of differentiation. Healthcare (10%) – The recovery of the important Senior Housing sector from recent oversupply has not been felt by many operators yet, though demographically driven demand is not going away. The recovery in Healthcare REIT prices has helped lower the cost of capital and reignited their acquisition activities in what remains a fragmented sector by property ownership. Long term, the aging population remains a positive demand driver for most healthcare property categories though healthcare policy and its potential impact on the sector remains uncertain in the medium-long term. MOB’s are the best performing sub-sector, while Senior Housing is the weakest with Life Science, Nursing Homes and Hospitals somewhere in-between. Industrial (9%) – Space demand from e-commerce related tenants remains strong and there is solid demand among more conventional users for more traditional properties. Supply has increased but in many of the major markets, it continues to lag demand levels, most notably in urban locations. Though the demand for e-commerce distribution space appears at present to be a secular/long cycle play, a continuation of trade disputes and a slower economy would not be a positive for warehouse/industrial space demand. Office (8%) – Space demand in the major ‘gateway cities’ (this includes New York, Washington DC, San Francisco) is generally steady with many markets said to be in equilibrium. Investors have become justifiably more concerned about the ‘true economics’ of being an office landlord (re CAPEX needs) and the rise of short-term shared office usage is seen as presenting some challenges. Direct investment interest
Uniplan REIT Outlook 2020
has remained fairly strong in the major metros though reduced involvement by foreign
buyers has taken some of the heat out of the market. There is some new supply coming
into markets. Currently, Technology, Advertising, Media and Information (TAMI) tenants
are more active than Financial Services.
Storage (5%) – The development of storage space has ramped up recently after an
extended period of light activity. Public Storage (PSA), the dominant storage company,
has delivered soft operational results over recent quarters – other storage companies
appear less affected. Space demand has been consistent.
Lodging (4%) – Rev Par (Revenue Per Available Room), the industry’s important
performance metric, has been bumping along at low levels over recent quarters. Soft
operational performance has been driven by sluggish leisure and business growth and
some competition from the likes of Airbnb. New supply has not been at worrisome levels
after new rooms were added in NYC and San Francisco some 18-24mths or so ago.
Other Sub-sectors - Diversified/Specialty (9%) – With many triple net landlords,
growth in earnings is often driven by acquisition activity rather than from the operation of
existing assets. Declining interest rates have helped maintain a low cost of capital for
many companies in these sectors. They have been able to enjoy a positive spread
between their initial property returns and the cost of funds on acquisitions. The Gaming
companies have emerged as active buyers of assets through sale & leasebacks
(propco-opco) deals. The purchase by Blackstone (BX) of the Bellagio (noted above)
has prompted broader investor interest. Also, relatively new to the public REIT markets
are the Advertising/Billboard companies – Lamar (LAMR) and Outfront Media (OUT) –
both are producing steady earnings improvement with some growth hopes pinned to
digital/new contracts.
The Uniplan REIT Team
December 2019
All investments carry a certain degree of risk, including possible loss of principal. REITs are
subject to illiquidity, credit and interest rate risks, as well as risks associated with small- and
mid-cap investments. It is important to review your investment objectives; risk tolerance and
liquidity needs before choosing an investment style. Value style investing presents the risk that
the holdings or securities may never reach their full market value because the market fails to
recognize what the portfolio management team considers the true business value or because
the portfolio management team has misjudged those values. In addition, value style investing
may fall out of favor and underperform growth or other style investing during given periods.
Uniplan Investment Counsel, Inc. is a registered investment advisor. The views expressed
contain certain forward-looking statements. Uniplan Investment Counsel believes theseUniplan REIT Outlook 2020 forward-looking statements to be reasonable, although they are forecasts and actual results may be meaningfully different. This material represents an assessment of the market at a particular time and is not a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding any security. Past performance does not guarantee future results. Prices, quotes, and other statistics have been obtained from sources we believe to be reliable, but Uniplan Investment Counsel cannot guarantee their accuracy or completeness. All expressions of opinion are subject to change without notice. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of this security. A list of securities purchased and sold in the portfolio during the past year, including the purchase or sale price and the current market price, is available upon request by calling262-534-3000. Uniplan Investment Counsel, Inc., does not advise on any income tax requirements or issues. Use of any information from this report is for general information only and does not represent personal tax advice either expressed or implied. You are encouraged to seek professional tax advice for personal income tax questions and assistance.
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