Emerging Markets Real Estate
Cohen & Steers
By Team
December 23, 2011
Emerging Markets Real Estate
Investment Commentary
November 2011
The following is our review and outlook for emerging markets real estate securities as of November 30, 2011. For the month, the FTSE EPRA/NAREIT Emerging Real Estate Index had a total return of –8.7% in U.S. dollars (net of dividend withholding taxes), compared with –5.6% for the FTSE EPRA/NAREIT Developed Real Estate Index (net), a broad measure of the global real estate securities market. Year to date, the indexes returned –27.5% and –7.3%, respectively.
Investment Review
Emerging markets real estate securities had a negative return in November following an exceptionally strong October. Worries about the global economy and Europe continued to weigh on equities broadly, while signs of slowing growth in China were of particular concern to developing countries. A sharp rally in the last few days offset some of the decline, as China cut its reserve requirement ratio for the first time in three years and central banks announced a coordinated effort to provide much-needed liquidity to European banks.
After rising nearly 30% in October, China (–17.2% total return - see note below) retreated amid signs that its economy was deteriorating rapidly. Falling property values and transaction volumes put significant strain on residential developers’ balance sheets, forcing many to unload inventory by cutting prices. Investors welcomed the government’s shift toward policy easing even though property-focused restrictions remained in place, as the move should help stimulate end-user demand.
In Brazil (–3.3%), slowing growth in developed economies continued to weigh on exports, contributing to flat GDP growth in the third quarter. This prompted a new round of measures to stimulate growth, including lower interest rates and sales taxes. As in other regions, commercial property owners outperformed residential developers, helped by continued strength in consumer spending.
Thailand (+7.4%) led all emerging markets, rebounding from October’s flood-related decline. South Africa (–0.8%) also outperformed, attracting investors with its relatively stable cash flows. Its financial market is also relatively closed off, and investors viewed it as less exposed to systemic financial risk related to European banks. In contrast, Poland (–14.1%) and Turkey (–10.0%) underperformed, as they depend heavily on Western Europe for financing.
In India (–18.4%), GDP growth fell to its slowest pace in more than two years. Wholesale inflation remained at nearly 10% in October (worse than economists expected), as massive government spending and a weak rupee fueled higher food and energy costs. Egypt (–20.5%) also saw heavy losses, resulting from deep political turmoil during the month.
Investment Outlook
We believe emerging market real estate securities stand to be direct beneficiaries of long-term secular trends, such as the expansion of urban centers and the rise of the consumer class, characterized by increasing household disposable income and greater access to credit. In the near term, investors should expect volatility to continue as markets grapple with uncertainty about Europe and further deceleration in economic growth.
A benefit of slowing global demand is that inflation has begun to moderate, leading many previously hawkish central banks to shift their attention to addressing growth concerns. We view China’s move toward policy easing as a particularly positive development for emerging markets given the country’s outsized role in global trade. While economic growth remains at risk in the short term, low interest rates and moderate inflation should set the stage for a meaningful recovery in demand in 2012.
In this challenging environment, we generally favor commercial owners over developers. Commercial property remains in short supply due to the limited availability of developable land and the slow pace of new construction in recent years. This has led to favorable operating conditions for large-scale landlords—especially those that control the most desirable locations.
On a country basis, we believe Brazil is among the most attractive markets in the world given its natural resources, growing consumption trends and shareholder-friendly business environment. We particularly like the retail market, which continues to see very strong fundamentals. We also favor Thailand, the Philippines and Indonesia, where domestic consumption remains strong and monetary policy has been effective. South Africa has exhibited relatively stable cash flows and low volatility, offering attractive diversification qualities.
China’s residential market continues to face substantial challenges, reflected in the very low multiples given to developers’ shares. We are carefully monitoring conditions on the ground for opportunities to capitalize on an inflection point in the sector. We remain very underweight in Mexico and have no exposure to European emerging markets. We continue to view property markets in the Middle East as unsuitable for investment due to political instability and corporate governance factors.
Notes:
Country returns are in local currencies as measured by the FTSE EPRA/NAREIT Emerging Index.
(c) Cohen & Steers
