A Midyear Look at Global Real Estate
Overall landscape
There are many drivers of recent short-term price changes for publicly traded real estate companies in the current market environment. These include changes in the market’s outlook for economic growth, for interest rate movements, for central bank actions and even the issues surrounding Greece and Ukraine.
However, we think the underlying economic and capital market conditions remain supportive for the global real estate sector and publicly traded real estate companies. The broad landscape remains one of low economic growth and low interest rates, even after the recent run-up in rates.
We also think moderate economic growth supports an improvement in real estate fundamentals. Positive economic growth typically drives an increase in demand for space, and that’s happening now without much new supply. We think that combination is a positive factor.
The capital market environment – with plenty of capital at attractive pricing – has been supportive of real estate values and also has provided companies with access to funding for growth. If conditions improve as the real estate cycle continues, we think they will begin to add value through development and redevelopment opportunities.
In summary, we think the broad landscape still is good for real estate fundamentals but we recognize that conditions can vary dramatically around the world. Our challenge in managing the Funds is to look for and take advantage of opportunities as they arise.
Fundamental factors
While fundamental factors differ markedly from market to market, we believe global real estate broadly is in a solid recovery cycle around the world. For example, the office space market has improved since the onset of the global financial crisis but rents still have not fully recovered in most areas. In markets where landlords have pricing power – such as in major cities including London and San Francisco – rents have risen to a level where new development is economically viable. This is providing opportunities to companies capable of creating new space.
In Europe, the U.K. has been strong and we think it remains one of the best markets across the globe. On the continent, we think economic and financial conditions are favorable. The overall economic outlook has improved this year, with the European Central Bank (ECB) easing of monetary policy, a decline in the euro and lower oil prices. Economic activity is increasing and growth is recovering, with year-over-year economic growth now near that of the U.S. Our favorite opportunities in Europe are in the northern region and in the retail sector on the continent.
In Asia, we think office market conditions have improved in many major cities. In Tokyo, for example, there has not been a significant tightening of occupancy over the past year and market rental reversions are turning positive, along with an improved market rental growth outlook. We now believe the growth in the revenuegenerating capability of Tokyo office space in the next three years is among the best in the world. We think the same can be said for office rental growth in Sydney, Australia, where we forecast more than 7% net effective rental growth per year over the next three years. The office market vacancy rate in Hong Kong has dipped to 2.3%, an extremely low level that means landlord pricing power strengthens immediately.
In the U.S., all sectors are showing rental rate growth and pricing power. Both the apartment and industrial sectors have seen market rental rates recover to levels prior to the global financial crisis and development opportunities are becoming more prevalent in both.
We think the fundamental backdrop for the global real estate industry means companies in the sector are positioned to generate unlevered, organic income growth from current properties of more than 3%. In general, we also think capital markets remain open for global real estate companies, whether they want to borrow because of current low interest rates or offer new equity. The real estate they own typically is in very high demand and the pricing for access has continued to increase.
In our view, the key takeaway is that public real estate companies globally are well positioned to continue to add value in today’s environment. Based on the solid fundamental outlook, projected growth rate and ability to grow through acquisitions or development, we think public companies in general can produce cash flow growth rates of about 7% over the next four years with steady dividends.
In addition, we also look at how the sector is priced relative to the value of the physical property the companies own, historic pricing levels and the broader debt and equity markets. Based on these metrics, we believe global real estate equities are trading broadly in line or with a slight discount to their historic levels.
Impact of rising rates
A key question for many investors is, “What happens to global real estate when interest rates rise?” Based on our research, rising rates are not necessarily bad for real estate investment trusts (REITs). We believe that the risk-return profile of REITs fits well between stocks and bonds. Real estate securities typically have an income component, represented by the dividend yield, as well as an equity component through their income growth that offers a potential hedge against inflation.
To a large extent, the response of this asset class to a rate rise will depend on the reasons for any rate increase. For example, if rates rise because of stronger growth or rising inflation expectations, then the impact may be muted by the potential for growth in the global real estate companies themselves.
We think the interest rate outlook for Europe has changed dramatically since the ECB began its quantitative easing bond-buying program. First-quarter economic data was better than the markets generally expected and we think the outlook for economic growth has improved. That means the outlook for real estate fundamentals in Continental Europe also have improved. In general, we think that region has shown the best relative improvement in outlook.
In our view, global real estate still offers potential opportunities for investors, based on the improvement in real estate fundamentals and the recovery in real estate values over the last five years. We think that the return potential will be more modest when compared with recent years, but still attractive relative to investments in stocks and bonds.
Past performance is not a guarantee of future results.The opinions expressed are those of the Funds’ managers and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through July 1, 2015, and are subject to change due to market conditions or other factors.
Risk Factors. The value of the Funds’ shares will change and you could lose money on your investment. Investment risks associated with investing in real estate securities, in addition to other risks, include rental income fluctuation, depreciation, property tax value changes and differences in real estate market values. Because the Funds invest more than 25% of their total assets in the real estate industry, the Funds may be more susceptible to a single economic, regulatory, or technical occurrence than a fund that does not concentrate its investments in this industry. International investing involves additional risks, including currency fluctuations, political or economic conditions affecting the foreign country, and differences in accounting standards and foreign regulations. These risks are magnified in emerging markets. The Ivy Global Real Estate Fund and Ivy Global Risk- Managed Real Estate Fund are non-diversified, meaning that they may invest a significant portion of their total assets in a limited number of issuers, and a decline in value of those investments would cause the Fund’s overall value to decline greater than that of a more diversified portfolio. There is no guarantee that the Ivy Global Risk-Managed Real Estate Fund will not decline in value in comparison with funds that do not use a risk-managed approach. These and other risks are more fully described in the Funds’ prospectus. Not all funds or fund classes may be offered at all broker/dealers.
The Ivy Global Real Estate Fund and the Ivy Global Risk-Managed Real Estate Fund are sub-advised by LaSalle Investment Management Securities, LLC.
© Ivy Investment Management Company
