By Eric Franco
Real estate stocks have now rebounded from the crash during the global financial crisis. But we think valuations are still reasonable, especially as property fundamentals continue to improve in key markets.
Since bottoming in early March 2009, global real estate stocks, as measured by the FTSE EPRA/NAREIT Developed Index, have performed strongly, recovering nearly all the losses suffered during the financial crisis. Now, many investors are asking whether global real estate stocks remain a worthwhile investment. We think the answer is yes.
While global real estate stocks may look pricier than other equities, valuations have only just recovered to levels that are average relative to their own history and they are still attractive when compared with bonds. For example, the cash-flow yield spread to 10-year government bonds remains well above normal.
The picture is brighter outside the US. Valuations of US real estate stocks are somewhat rich relative to their own history, but stocks remain attractive relative to bonds. Outside the US, however, real estate stocks still trade below their historical average and also look very appealing versus bonds.
These valuations are underpinned by two key trends. First, both debt and equity financing are relatively accessible and inexpensive. Second, despite ongoing macroeconomic volatility, real estate fundamentals are generally resilient or improving across the world, from the Pacific Rim to Latin America.
In Asia, improving economic conditions are bolstering the property markets. In Japan, the office market is showing initial signs of a recovery in rents and vacancy rates after a prolonged downturn. Liquidity remains abundant in other developed economies such as Singapore and Hong Kong. Even in China, where the government has recently taken cooling measures, we think the real estate market is less vulnerable to tightening than widely perceived.
Europe remains a weak spot. While property demand is still challenged, supply has been constrained for many years. Few public companies are developing properties, which should support occupancy rates and pricing.
In the US, most segments of the property market are performing well. Many retail shopping centers are benefiting from improving rents, and occupancy levels are now close to those of the previous cyclical peak. Among the more economically sensitive lodging stocks, occupancy in many markets has also recovered, which should lead to ongoing increases in revenue per available room.
While the recovery in asset values has been more pronounced in US coastal urban areas, it's now spreading to secondary and suburban markets. This is being driven by higher prices (and hence lower investment yields) of property in coastal urban markets and a further loosening of debt markets. Against this backdrop, US real estate buyers are going to the suburbs to hunt for higher-yielding bargains.
South of the border, public real estate stocks in Mexico are also worth a look. In the retail and office market, a consolidation of ownership is likely to drive property prices higher.
For investors, global real estate stocks offer a good way to capture these trends in an asset that provides diversification benefits to both stocks and bonds. Since many of these stocks are structured as real estate investment trusts (REITs), they're required to distribute most of their earnings as dividends, providing a solid source of income. It's true that dividend yields have fallen as stock prices have increased in recent years. But as profitability in property markets continues to improve, real estate stocks remain a good option for investors seeking income-producing investments in today's low bond yield world.
Eric Franco is Senior Portfolio Manager—Global Real Estate Strategies at AllianceBernstein.