Re-engaging with listed real estate makes sense right now as the market is at an inflection point with the Federal Reserve poised to cut interest rates shortly, according to Andy Cox (pictured), equity investment specialist at Janus Henderson.
Listed real estate has endured a torrid couple of years as at the same as valuations have come down quite considerably, public real estate companies are also trading at wide discounts to their net asset value.
Although, there are some indications that things may be starting to change as the Fed has given strong indications it will begin cutting rates soon and more investors are broadening their exposure from a narrow list of tech names.
“All in all, there have been reasons to avoid the sector, but we’re seeing that inflection. We’re seeing those headwinds turn into tailwinds. Interest rates are expected to come down now inflation is under control so that basically means that this correction because of interest rates going higher should reverse,” said Cox.
“Coupled with that, we’ve got a sector that’s pretty much out of favour. People have been going into tech, they’ve been going into other areas. It’s pretty much an unloved sector. Again, we expect to see an inflection point with more capital flows coming into it, which should be positive.”
Return of the relief rally
Despite enduring a difficult couple of years, listed real estate was actually one of the best performing sectors from October onwards last year when the relief rally began on expectations that the Fed would soon begin cutting interest rates.
From October 27 until the end of the year, the FTSE EPRA Nareit Developed index gained 23.29% compared with a 16.23% rise in the S&P 500.
That rally proved to be short-lived as concerns mounted about the likelihood of future rate cuts. The broader stock markets outstripped the public real estate market during the first half of the year with the FTSE EPRA Nareit Developed index generating a -3.17% return compared with a 15.29% gain for the S&P 500.
Cox notices though that the performance from July onwards has seen a return to the experience of late last year, which he expects to last. The FTSE EPRA Nareit Developed index generated a return of 13.22% from 1 July onwards compared with a 2.96% rise in the S&P 500.
“The performance in the first half frankly speaking was pretty rational. People were worried that the Fed wasn’t going to cut rates and the 10-year yield actually went up, but now we’re back to where we were in Q4 last year. It feels like it was a bit of a false start back in October but it showed us what would happen or could happen when interest rates do start to come down,” said Cox.
“That’s what’s caused that rerun of what we saw in October last year. We’re still early stages. But if you believe interest rates are going to come down, we think this is marking the point where we’re going to see more interest in the sector.”
Bounce back of different sectors
One of the most notable things about the bounce back in performance of listed real estate from last year’s lows in October is the extent to which it has been driven by sectors which have until recently been out of favour with investors, such as offices, while some of the long-term structural winners like data centres have fared less well.
Cox notes that this is mostly a reflection of the deep discounts that existed in some of those sectors that have performed better, which was not the case with data centres, for example. Although, he notes that the underlying performance of data centres has been positive, which is a sector he is constructive about.
“Data centres is clearly a very exciting sector in general in terms of what’s happening with generative AI. You’re also seeing it with real estate. These data centre companies need to host cloud platforms, the hyperscalers need more space. So again there’s really good opportunities and some of the best players in the data centre space are listed companies,” he said.
Overall, he notes that there is a great deal of dispersion within different sectors and there are pockets of opportunity in a number of different sub-sectors so it is difficult to make any specific calls on different sectors.
“What we tend to see is that each of the sub-sectors, the different types of real estate, have quite a dispersion between the better performing companies and the worst performing companies. So, we’re not just saying we want to own industrial, office or even retail because within that the average might be pretty uninspiring but there are probably some very good opportunities, which we will target” he said.
Bottom-up investors
Janus Henderson’s flagship property fund, the Horizon Global Property Equities Fund, reflects this approach as it places a lot of emphasis on the skills of its managers in identifying the right companies rather than relying on top-down macro views.
“We’ve got portfolio managers and analysts in the US, in Europe and in Asia. We spend a lot of time on the ground seeing companies in the markets, seeing first hand what’s going on. That’s what we’ve done for over 20 years and that remains very true today. At the same time, we know what we’re good at and what we’re not good at. We’re not going to be making big macro calls. We’re not going to be saying we’re leaning into one region over the other,” said Cox.
This emphasis on bottom-up stock selection rather than top-down macro views is most clearly represented in the fund’s regional allocations, which are fairly evenly weighted compared with the benchmark.
Having said that, there are some small differences, notably that the strategy has less exposure than the benchmark to Hong Kong and China because of the difficulties in the real estate sector there.
Conversely, Cox is constructive about Japan despite the fact that the Bank of Japan is adopting a more hawkish policy, noting that the change in monetary policy is a reflection of the fact that the economy is on a much firmer footing compared with previously.
Diversifying a portfolio
The performance of the strategy has been strong over the long-term as it ranks as a second quartile and first quartile fund on a five-year and 10-year basis, according to FE fundinfo.
Cox makes the case that even though this focus on security selection has been less critical in driving performance in recent years, it makes sense long-term to focus on active management given the diversity within listed real estate.
“The overall landscape of listed real estate has really evolved in terms of the quality of companies you can invest in, the quality of real assets, the type of opportunities you can participate in. It’s much more diversified. It used to be office or just retail or worse, diversified so you had a bit of everything in there,” he said.
Overall, he notes also the role that listed real estate plays in a portfolio, acting as a diversifier, something which he says a lot of investors should be cognisant of.
“People have lost sight a little bit for what real estate is there for. Real estate is a core allocation but there are certain points in the cycle where you want to increase your exposure and you may want to decrease your exposure. But generally speaking, now we’re at a point where people tend to be underinvested or it’s a very small proportion of their portfolio and we see now as a good opportunity to have that core allocation going through,” he said.
Andy will be joining Fund Selector Asia at our flagship FSA Investment Forum Thailand on 12 September 2024 where he will be presenting An inflection point for REITs.
Find out more about his session and the event below.
