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How global property equities will fare in 2015
In assessing the outlook for the sector we focus first on the direct (physical) property markets to which our universe is exposed, and second on the likely appetite of investors toward property shares taking into account current valuations, says Guy Barnard, co-head of global property equities at Henderson Global Investors
Guy Barnard 7 Jan 2015
 
   

2014 has taken most forecasters by surprise. Consensus positioning towards rising government bond yields and the potential negative impact for equity markets proved to be wide of the mark. This leaves us with a strong sense of déjà vu. Today, the US 10-year treasury yield is about 2.3%, having started the year at 3% and touched a low in October (briefly) back below 2%, despite the US Federal Reserve ending their QE programme.

 

Geopolitical tensions, weaker-than-expected global growth, deflationary risks and renewed stimulus measures in Japan and the Eurozone have all contributed to this unexpected outcome. Against this backdrop, world equities have made healthy gains and property and property equities have outperformed.

 

So, what are the prospects as we look into the year ahead?

 

In assessing the outlook for the sector we focus first on the direct (physical) property markets to which our universe is exposed, and second on the likely appetite of investors toward property shares taking into account current valuations. The former is relatively easy to ascertain, the latter much more difficult.

 

Starting with the direct market, the fundamental case for property investment remains strong. This has been reflected in elevated levels of investor demand for real estate globally. DTZ, in their latest money into property survey, identified US$408 billion of equity demand for real estate assets, the highest level since 2007. We expect this weight of capital to underpin global property yields (cap rates) at, or around, current levels as we look to 2015.

 

Turning to regional prospects, in North America we expect 2015 growth in funds from operations (FFO) to be in the order of 7%-9%, similar to what it has been for 2014. Property yields have continued to firm in the US, as elsewhere, with historically low yields now evident in the gateway office markets and the Grade A mall space. However, average yields of 6% are still a healthy 3.6% higher than 10-year Treasury yields, higher than the long-term average and underpinned by the potential for income growth, which remains on a positive trend. With shares trading at around NAV following a strong run in 2014 we maintain a relatively neutral stance towards the region.

 

The situation in Asia-Pacific has been far more uncertain, with stark contrasts between the key markets. In Japan, 'Abenomics' has continued to push up capital values. The additional stimulus measures recently announced are likely to give a further boost to the asset reflation cycle. Encouragingly, upside from this alone, isn't the key driver as we are beginning to see signs of rental growth in the key Tokyo office market. Stock prices had got ahead of fundamentals at the start of the year, but, after weak performance this year, offer greater value again. J-Reits should also remain well-supported as the Bank of Japan has tripled its J-Reit purchase programme to 90 billion yen per annum, while dividend yields of 3.3% should appeal to income investors.

 

Elsewhere in Asia-Pacific, in Australia top-line growth prospects appear modest as the economy slows, but given a lower cost of debt and an attractive starting yield, shares should deliver a single-digit return assuming no change in the multiple. In Hong Kong and Singapore, office markets have remained resilient, but retail spending has deteriorated, particularly at the luxury end, leading to some rental pressures. Both markets have also been subject to residential cooling measures, which have slowed the rate of growth, but not led to the widespread declines many predicated at the start of the year. We expect more of the same next year. With sentiment still weak and currency risks rising, we believe it is still too early to take a more constructive view on the Asia-Pacific region.

 

Within Europe we see further prospects for growth in 2015, most notably in the UK, where recent economic and employment growth, coupled with a lack of new supply, suggest we could see rental growth in the key London office market of 5%-10% p.a. in the coming years. Conversely, we remain underweight continental retail landlords, where constrained consumer spending, online shopping and low inflation are all likely to restrict growth prospects. With pockets of growth and attractive dividend yields elsewhere in the Eurozone, even with lower growth, we think the sector remains well placed, therefore we have a small overweight to the region, having added exposure over the year.

 

In summary, we believe property as an asset class remains well placed, with investor demand continuing to strengthen as institutions rebuild historically low property allocations. This, combined with the healthy yield spread of property over bonds, should continue to support asset prices, even as bond yields rise. While will may revisit the concerns about rising interest rates again, evidence from previous tightening cycles suggests that property markets do not tend to demand higher returns as rates initially rise. If anything, property yields tend to see modest downward pressure during these phases as rising rental growth leads to increased investor interest. While it we would not expect history to repeat itself exactly, it will probably rhyme.

 

Guy Barnard is the co-head of global property equities at Henderson Global Investors

 

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