Welcome to the brave new world. Western economies are stuck in what former Federal Reserve treasury secretary Larry Sumner calls “secular stagnation” and are addicted to “unconventional monetary policy”.
The by-products are asset price bubbles, which central banks argue are a small price to pay to stave of deflation. Everyone is making money but a REIT chief executive last week observed that “the market is so hot it’s making everyone look good”.
The European Central Bank finally jumped on the quantitative easing band wagon by cranking up money supply with a €1.1 trillion “big bazooka”, Eurozone bond yields have slumped and the currency has dropped to 75p against the pound. Stock markets have been buoyed and cyclical sectors have outperformed. UK REITs are already up 9% in January after a 15% rise last year, making them one of the best-performing stock market sectors.
A year ago, we bought REITs as the real estate market was in a sweet spot with the twin drivers of falling cap rates and rising rents. I am sticking with these themes for 2015. In the interim reporting round of 30 September 2014 portfolio valuations, REITs beat the market, delivering net asset values predicted for 31 March 2015.
The Bank of England’s monetary policy committee has seen its remaining hawks turn dovish with a unanimous vote to keep UK base rates on hold at 0.5% and sees a “roughly even chance” that inflation will go below zero in the first half of 2015. Weakness in the global economy has led the International Monetary Fund to downgrade its global growth forecasts for 2015 and 2016.
So where can this dream sequence go wrong? I always start to worry when everyone is a buyer. The latest data from CBRE cites strong investment demand and low bond yields pushing prime property yields lower across sectors, but rental improvements remain patchy and led by key office markets. For REITs, the risk now is that as the bears capitulate they start playing leapfrog with their NAV forecasts and start building in undeliverable expectations of balance sheet growth.
There hasn’t been much corporate data in January. We think Land Securities may have become too cautious too early and should have more development and leveraging with the portfolio effectively full. The shares are up 30% in three months and the market capitalisation is back to £10bn. But while that is where it was in 2007, the net rent roll has not grown appreciably.
We don’t think this is a conventional cycle: it’s shaping up to be a period of protracted low interest rates and low inflation or deflation-lite growth.
Retailing is still weak with store prices down by 2.2% year-on-year. The US imports of Black Friday and Cyber Monday saw discounting sustained through the festive period. Shopping centre landlords still seem to be putting too much faith in footfall feeding through into sales and rental growth, but household consumption is still adjusting to 0.5% inflation with big ticket purchases being deferred.
If we are right, then real estate works as a fixed-income investment with any rental growth in for free. Reminiscing as to how Derwent London and Great Portland Estates won the recovery by having the most balance sheet firepower is fine if you can identify what precipitates prime product coming on the market cheaply. But I can’t and I don’t think anyone else can either.
Mike Prew is managing director and head of real estate at Jefferies
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