Topic Tags: Real Estate

New GICS Real Estate Sector

September 2016

S&P Dow Jones Indices and MSCI Inc. have announced the creation of a new real estate sector within the Global Industry Classification (GICS) system. Effective market close August 31, 2016, real estate officially became its own GICS sector, whereas it was formerly included within the financial sector. MSCI implemented this new classification change as of this date, but S&P Dow Jones indices will not see this change made until their quarterly index rebalance date of September 16th. Russell indices will not be affected since they utilize a separate classification system from GICS.

Download PDF

Do Rising Interest Rates Mean Higher Cap Rates for Real Estate?

One of the best performing and consistently stable asset classes over the past several years has been real estate. Based on the NCREIF-ODCE Index real estate has returned an annualized 12.7% over the last five years.

One of the best performing and consistently stable asset classes over the past several years has been real estate. Based on the NCREIF-ODCE Index, real estate has returned an annualized 12.7% over the last five years. Much of the sector’s success has been attributed to strong fundamentals which have translated into cap rate1 compression. Although cap rates are at historical lows and unlikely to compress much further, the unusually low interest rate environment combined with the spread between cap rates and risk-free Treasuries continue to make real estate investments look relatively attractive. Going forward, in anticipation of the Fed raising interest rates, we expect the current relatively wide cap rate to Treasury spread will provide a measure of cushion to allow long-term interest rates to rise without drastically impacting cap rates and the overall value of real estate.

 

1Cap rate is the net operating income divided by property value

Are Real Estate Returns Headed for a Correction?

Core real estate investments have flourished since the financial crisis, with the NCREIF Property Index (“NPI”) returning 13.3% in 2015, its sixth consecutive yearly gain after the real estate recovery began in 2010. Not surprisingly, investors are now wondering if this run can continue, or if it is time to pull back on their allocations to real estate.


Core real estate investments have flourished since the financial crisis, with the NCREIF Property Index1 (“NPI”) returning 13.3% in 2015, its sixth consecutive yearly gain after the real estate recovery began in 2010. Not surprisingly, investors are now wondering if this run can continue, or if it is time to pull back on their allocations to real estate. In this week’s chart, we look at the historical total returns of the NPI going back to 19782 broken out by appreciation and income. The NPI was first launched in 1978, and since then, real estate cycles have historically lasted more than 10 years. The first cycle featured 13 years of positive total returns followed by a negative 5.6% return in 1991 as a result of severe oversupply in the market. These negative returns only lasted two years before again turning positive from 1993 until 2008, when returns flipped negative due to the global financial crises.

Since the Global Financial Crisis, core real estate has made a robust recovery, generating double-digit returns over the past six years, but the real question is whether or not such impressive returns can continue. On one hand, supply for most commercial real estate sectors is still below their pre-recession averages, cap rates may compress further given their spread to Treasuries, income levels are favorable, leverage is manageable, and debt maturity profiles are appropriately structured. On the other hand, valuation levels are high as a result of price appreciation, and significant capital has flowed into the asset class. Ultimately, we do not believe that real estate returns are poised for a correction, but anticipate they will retreat from the double-digit territory we have seen over the past six years to a more realistic mid- to high-single-digit range.

 

1The NCREIF Property Index measures the return of individual commercial real estate properties that are acquired in the private market for investment purposes only.

2Inception year of the NCREIF Property Index was 1978

2016 Market Preview

January 2016

Similar to previous years, we offer our annual market preview newsletter. Each year presents new challenges to our clients, and 2016 is off to a volatile start with equity markets down significantly, oil dropping below $30, the Fed poised to further increase interest rates, and fears of a China slowdown rippling through the markets. However, other headlines will emerge as the year goes on, and it is critical to understand how asset classes will react to each new development and what such reactions will mean to investors. The following articles contain insightful analysis and key themes to monitor over the coming year, themes which will underlie the actual performance of the asset classes covered.

Download PDF

Asset Class Review: What Has Worked So Far in 2015?

This week’s chart shows broad asset class returns through July 31st of this year. Perhaps the most surprising performer has been international equity, which has outperformed even U.S. equities. Much of the outperformance is due to the strong U.S. dollar, which has increased international developed countries’ exports and the number of tourists.

This week’s chart shows broad asset class returns through July 31st of this year. Perhaps the most surprising performer has been international equity, which has outperformed even U.S. equities. Much of the outperformance is due to the strong U.S. dollar, which has increased international developed countries’ exports. The same factor has in turn contributed to the lower performance of U.S. equities. With so many of the S&P 500 companies’ revenues dependent on international growth (about 46%), the strong dollar has weighed heavily on EPS growth. In addition, the same factors many of our readers have heard before — the slowdown in the energy sector and the cold winter — have also played major roles.

The other darling this year, as widely predicted, has been Real Estate. Throughout the first half of the year, growth has in large part been due to income, lease turnover, and appreciation (most notably in the Southwest U.S.). The remainder of the year is likely to see less contribution from income and more contribution from appreciation.

Now let us turn to the poor performers. Bonds, both Global and U.S., continue their same old story: the specter of the Fed rate hike continues to loom, in addition to the Greek debt crisis and China’s now not-so-secret efforts to prop up growth. Emerging Markets have been the worst performers this year, thanks in large part to their dependence on commodities and the domino effect of China’s slowing growth which has translated into weakening currencies.

Where will the rest of the year take us? As the issues we have discussed will continue to weigh on asset classes, it will not be surprising if meandering to disappointing returns across asset classes continue for the rest of 2015.

1 Real Estate Returns through 6/30/15; Private Equity Returns through 3/31/15

Creating Social Impact Through Responsible Investing

August 2015 Investment Perspectives

A growing population of socially conscious investors has energized socially responsible investment (SRI) strategies in the past decade. The Forum for Sustainable and Responsible Investment defines SRI as the process of integrating personal values and societal concerns into investment decision making. SRI has increased in the U.S. from $639 million in 1995 to $6.6 trillion in 2014. These assets account for roughly 17% of total dollars under management in the U.S.

This newsletter outlines a brief history of SRI, approaches to implementing an SRI program including positive and negative screening and shareholder activism; impact investing; example products and solutions in equities, fixed income, and real estate; investor concerns around performance and fiduciary liability, and considerations for implementing a sustainable investing program.

Download PDF

The Impact of Interest Rates on Real Estate Returns

As the U.S. faces a potential interest rate hike this fall, it is worthwhile to review the impact of interest rates on the real estate sector. This week’s chart looks at the historical performance of the NFI ODCE Index versus the 10-Year Treasury.

As the U.S. faces a potential interest rate hike this fall, it is worthwhile to review the impact of interest rates on the real estate sector. This week’s chart looks at the historical performance of the NFI ODCE Index versus the 10-Year Treasury. The correlation between the two variables is positive but weak, owing in part to a time lag between the change in interest rates and when the change impacts property values.

A moderate interest rate hike after the Financial Crisis may be viewed as the Fed’s vote of confidence that we are seeing economic recovery. Factors that drive interest rates up — such as inflationary pressures from economic growth — cause real estate fundamentals to improve and potentially offset the negative impacts of rising rates. Additionally, we expect to see income rise as property managers pass on higher interest rates to tenants by increasing rents, thus providing a partial hedge against rising rates. While we are still in the initial expansion stage, economic growth and rising interest rates should prove accretive for real estate investments.

Relative Yields for REITs and MLPs Trending Up?

Given the prolonged low rate environment in the aftermath of the credit crisis, investors have been on a continual search for yield. Historically, REITs and Master Limited Partnerships (“MLPs”) have been among the highest yielding asset classes, which led to strong performance in the years following the 2008 financial crisis.

Given the prolonged low rate environment in the aftermath of the credit crisis, investors have been on a continual search for yield. Historically, REITs and Master Limited Partnerships (“MLPs”) have been among the highest yielding asset classes, which led to strong performance in the years following the 2008 financial crisis. However, since the taper tantrum in May of 2013 MLPs and REITs have underperformed the S&P 500 by 1,136 and 648 bps, respectively.1 Currently, REITs2  and MLPs3  are yielding 3.8% and 6.0% compared to the S&P 500 yield of 1.9% as of May 2015.

This week’s chart looks at the historical relative yields of REITS (red lines) and MLPs (blue lines) compared to the S&P 500. The chart shows that if you owned MLPs or REITs since June 2006, on average, you were receiving 3x and 2x yield over the S&P 500 respectively. However, by early 2013 both MLPs and REITs looked expensive based on their yields relative to the S&P.4 Of course, given the underperformance of both MLPs and REITs over the last few years, the relative yields of both asset classes are again starting to look more attractive. REITs still seem a little expensive as yields remain relatively low (compared to history) but MLP yields (relative to the S&P) are now above their long-term average and look relatively attractive, and may present an opportunity for investors to boost portfolio returns.

1 As of May 29, 2015
2 REITs are represented by the FTSE NAREIT All Equity REITs Index
3 MLPs are represented by the Alerian MLP Index
4 Prices are inversely related to yields: if the yield is below the average it is more expensive

Is Home Ownership a Thing of the Past?

Home ownership has historically been part of the American dream; however, recent data trends show that more consumers are postponing or bypassing this life event in favor of renting. The sting of the Great Recession still resides within consumers’ minds, many of whom are still struggling from a period in which millions of homes went into foreclosure and trillions of dollars of home equity was wiped out.

Homeownership has historically been part of the American dream; however, recent data trends show that more consumers are postponing or bypassing this life event in favor of renting. The sting of the Great Recession still resides within consumers’ minds, many of whom are still struggling from a period in which millions of homes went into foreclosure and trillions of dollars of home equity was wiped out. While the devastating housing crash is certainly one culprit, a shift in millennials’ attitudes could also be contributing to this change in sentiment.

In this week’s chart, we examine the declining rate of homeownership versus the increasing costs of renting. Despite the attractive level of home affordability, homeownership is at its lowest level in 29 years and monthly rents are at an all-time high. In ten short years, the percentage of non-vacant housing units occupied by the unit’s owner has declined from its 2005 peak of 69.1% to just 63.7% this year. Meanwhile, the median monthly asking rent has risen 31.4% during the same period. The U.S. Census Bureau reported that the most recent median asking sales price was $149,500, the same nominal levels we were seeing in the latter part of 2005 but significantly lower than the 2Q 2007 peak of $201,500.

While the U.S. economy has made great strides in its economic recovery, the housing market has yet to come out of its shell. The impact of increased home purchase activity and its resulting consumption effect would be a boon to the domestic economy. Thirty-year mortgage notes can still be obtained for less than four percent interest, but the availability of cheap credit has not been enough to drive more millennials into homeownership. As we debate the impacts of tightened monetary policy by the Federal Reserve, the consequences of rising interest rates and its direct effect on the housing market cannot be ignored.

Is Real Estate Overvalued?

The core real estate market has enjoyed a solid run over the last five years. However, outsized returns do not last forever and for this reason investors are starting to question future return prospects for the asset class. There are several metrics to consider when answering such a question and this week’s Chart of the Week looks at one such metric: new supply.

The core real estate market has enjoyed a solid run over the last five years. However, outsized returns do not last forever and for this reason, investors are starting to question future return prospects for the asset class. There are several metrics to consider when answering such a question and this week’s Chart of the Week looks at one such metric: new supply.

The chart above compares new supply as a percentage of existing stock across the four main property sectors. As the chart indicates, current levels of new supply remain below the pre-recession averages for three out of the four sectors. That affords some comfort. However, new supply of apartment properties has exceeded its pre-recession average. Indeed, a lot of the supply in apartments has been driven by an increase in true rental demand, but the data suggests that the apartment sector may come under pressure in the near- to medium-term if new supply continues to rise. According to this metric, opportunity still remains in the retail, office, and industrial sectors. Ultimately, though, new supply is just one metric to consider when gauging the current state of the real estate market. Other important items to monitor include performance, valuation, debt, income, and capital flows. Our recently released newsletter, The State of Real Estate: Is the Run Over?, analyzes these metrics to formulate a view on future return prospects for the asset class.