- The real estate securities market may be starting to favor higher-quality companies versus the lower-quality companies that outperformed following the financial crisis.
- We believe quality is the best indicator of long-term investment potential, and we look for higher-quality companies with below-average debt levels.
- Boston Properties is an example of a company that is creating value that hasn’t yet been fully rewarded by the market.
U.S. and overseas real estate equity markets have started 2014 positively. With continued improvement in real estate fundamentals, the real estate securities market may be turning in favor of companies with greater earnings growth prospects as well as active management and development capabilities. We believe our approach to investing in higher-quality companies with below-average debt levels has the potential to benefit investors going forward.
Following the global financial crisis, highly leveraged, lower-quality companies significantly outperformed companies with better balance sheets and higher-quality real estate assets. This outperformance occurred as lower-quality companies rushed to shore up their balance sheets and take advantage of much-reduced costs of debt. In recent periods however, higher-quality companies have begun to outperform, as improving real estate markets and economic growth have allowed investors to focus on companies that create fundamental value and deliver the best earnings and dividend growth outlooks.
While "quick fixes" by lower-quality companies can sometimes be effective in the short term, we believe quality is the best indicator of long-term investment potential, and that's where our focus lies. In the U.S. and limited portions of Europe, we continue to emphasize companies that have highly visible development pipelines. As long as gross domestic product growth remains positive, we believe occupancy rates and lease rates are likely to rise because there's been relatively little new supply in most markets. Public real estate companies that had the financial flexibility to be the first companies to deliver new developments into the strengthening real estate markets have outperformed recently - and these are the type of companies, especially in the U.S., in which we're overweight.
Boston Properties' (NYSE:BXP) Salesforce (NYSE:CRM) Tower, under construction in San Francisco, is a great example of how analysts don't always correctly evaluate a development's potential. (Boston Properties accounted for 4.50% of Invesco Real Estate Fund, 0.72% of Invesco Global Real Estate Income Fund, 2.61% of Invesco Global Real Estate Fund and 2.60% of Invesco V.I. Global Real Estate Fund as of March 31, 2014.) The project began in 2012 with certain assumptions for profit margins, yields and value creation. As the San Francisco real estate market and economy have improved since then, rental rates have trended higher and initially assumed value creation of around $200 million is now estimated at upwards of $400 million. The important takeaway is that this increase isn't factored into analysts' estimates of current earnings - but this is a longer term source of value. And we believe this is a perfect example of a company creating value that has yet to be fully rewarded in the market.
Our investment discipline is focused on the long term, and we're going to stick to our fundamental beliefs: investing in higher-quality companies with better fundamental growth opportunities that we can access and own at reasonable valuations. That's what we've always believed in, and we believe that the markets are now catching up with our point of view.
The Invesco variable insurance funds are used solely as investment vehicles by insurance company separate accounts to fund variable annuity contracts and variable life insurance policies. Shares of funds cannot be purchased directly. Invesco Distributors, Inc. does not offer any variable products.
Holdings are subject to change and are not buy/sell recommendations.
Investments in real estate related instruments may be affected by economic, legal, or environmental factors that affect property values, rents or occupancies of real estate. Real estate companies, including REITs or similar structures, tend to be small and mid-cap companies and their shares may be more volatile and less liquid.
The risks of investing in securities of foreign issuers can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.
In general, stock values fluctuate, sometimes widely, in response to activities specific to the company as well as general market, economic and political conditions.
An investment in emerging market countries carries greater risks compared to more developed economies.
The prices of and the income generated by securities may decline in response to, among other things, investor sentiment, general economic and market conditions, regional or global instability, and currency and interest rate fluctuations.
Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa.
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Disclosure: The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. The opinions expressed are those of the author(s), are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.