a case for allocating to global real estate securities/media/files/b/...publi securities roup i 4...

PUBLIC SECURITIES GROUPi | 4Q 2018 | REAL ESTATE

MANAGER INSIGHTSDECEMBER 2018

1FOR INSTITUTIONAL USE ONLY: NOT FOR DISTRIBUTION TO THE PUBLIC.

A Case for Allocating to Global Real Estate Securities

E X E C U T I V E S U M M A R Y

We are often asked by clients and prospects whether today’s global listed real estate valuations warrant an allocation to the asset class. Our view is that listed real estate is more of a timeless, long-term strategic allocation, based on the historical investment characteristics of the asset class, including:

■■ Income: Historically, global real estate securities have provided an attractive source of income.

■■ Insulation from Inflation: The asset class has also exhibited positive inflation sensitivity, which has led to attractive total returns when inflation has moved higher in the past.ii

■■ Asset Class Diversification: As a portfolio diversifier, adding global real estate securities to a traditional portfolio of stocks and bonds has added to the long-term portfolio efficiency of a traditional stock and bond allocation.iii

That said, as specialized managers of listed real estate portfolios, we do not lose sight of the market’s more timely considerations. Based on current market observations, we see global listed real estate as an attractive entry point for long-term investors across several dimensions:

■■ Attractive dividend yields: As of September 30, 2018, global real estate securities had a current yield of 4.1%, versus 2.4% for the MSCI World Index and 2.2% for the Bloomberg Barclays Global Aggregate Index.iv

■■ Moderate correlations to equity and fixed-income asset classes: The complementary return profiles of global real estate securities are now only moderately correlated with global equities and global fixed income at 0.46 and 0.36, respectively, on a trailing one-year basis.v

■■ Near-term considerations, based on performance trends and industry fundamentals: We largely attribute listed real estate’s recent relative underperformance to interest-rate concerns— and not to industry fundamentals, which appear positive across most regional markets and property types. To us, the sharp increase in U.S. interest rates toward their 15-year average suggests that near-term interest-rate risk is largely priced into the market. Overall, we believe the improvement in balance sheets over the past decade further decreases the risk associated with rising rates.

■■ Valuation-driven opportunities across sectors and regions: From a valuation perspective, our research shows that global real estate securities are trading at an overall discount to net asset value (NAV). At September 30, 2018, this discount was more than 700 basis points below the average premium/discount since the beginning of 2000.vi Across individual sectors and regions, we continue to see a wide range of valuations, driving opportunities to invest at attractive values, relative to history. Two timely examples are highlighted in this report: U.S. West Coast office properties and Japanese developers.

But first, we delve into three of the timeless goals that support a long-term listed real estate allocation, as part of a diversified investment framework: income, insulation from inflation and asset class diversification.

2

FOR INSTITUTIONAL USE ONLY: NOT FOR DISTRIBUTION TO THE PUBLIC. BROOKFIELD OVERVIEW FACT SHEETA CASE FOR INVESTING IN GLOBAL REAL ESTATE SECURITIES

E X H I B I T 1 : T H E A N N U A L I N CO M E R E T U R N S O F S T O C K S , B O N D S A N D G L O B A L R E A L E S TAT E S E C U R I T I E S (%)

E X H I B I T 2 : D I V I D E N D G R O W T H : G L O B A L R E A L E S TAT E S E C U R I T I E S V S . T H E R AT E O F I N F L AT I O N

T I M E L E S S I N V E S T M E N T C O N S I D E R A T I O N S :

A SOURCE OF ATTRACTIVE INCOMEOver the long term, global real estate securities have delivered higher full-year annual income returns than both global equities and global fixed income. In large part, we attribute these results to the real estate business model, which is focused on generating stable, recurring cash flows derived from leases on the underlying real estate. Many global real estate securities are structured as REITs, which are generally required to distribute at least 90% of net income to shareholders, further supporting the income orientation of the asset class. Exhibit 1 highlights the annual income returns of global real estate securities, global equities and global bonds from 2006 through 2017.

GLOBAL REAL ESTATE SECURITIES HAVE DELIVERED A DECADE OF HIGHER ANNUAL INCOME RETURNS VERSUS GLOBAL EQUITIES AND GLOBAL FIXED INCOME

As of December 31, 2017. Sources: Bloomberg and Morningstar. Data available from January 2006, reflecting the first calendar year available for the FTSE EPRA/NAREIT Developed Index. See index definitions at the end of this report.

As of December 31, 2017. Source: Bloomberg. Data available from January 2006, reflecting the first calendar year available for the FTSE EPRA/NAREIT Developed Index. See index definitions at the end of this report.

Historically, the cash flow growth of global real estate securities has risen at a higher pace than inflation, as shown in Exhibit 2. We attribute this growth to the ability of landlords to raise rents in periods of rising inflation as leases expire and demand rises. Generally, more economically sensitive property types with shorter lease terms (such as hotels and self storage), as well as apartment properties, tend to have a greater sensitivity to inflation.

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

201720162015201420132012201120102009200820072006

3.6%

4.3%

1.8%

3.3%

4.4%

1.8%

4.7%

4.4%

2.3%

5.1%

4.1%

2.4%

4.0%

3.7%

2.0%

3.9%

3.5%

2.2%

4.0%

3.2%

2.3%

3.6%

3.1%

2.1%

3.8%

3.0%

2.0%

3.6%

2.8%

1.9%

3.7%

2.6%

2.1%

4.0%

2.5%

1.9%

-10.0%-8.0%-6.0%-4.0%-2.0%0.0%2.0%4.0%6.0%8.0%

10.0%12.0%

201720162015201420132012201120102009200820072006

2.5%

10.2

%

4.1%

0.5%

3.0%

9.6%

1.7%

8.6%

2.1%

4.8%

2.1%

6.3%

0.7%

8.4%

0.8%

6.5%

1.5%

7.3%

1.5%

-0.4

%

2.7%

-7.5

%

0.1%

-0.4

%

FOR GLOBAL REAL ESTATE INVESTORS, WE LIKEN THE PAST DECADE’S DIVIDEND GROWTH TO AN ANNUAL PAY RISE, OVER AND ABOVE THE RATE OF INFLATION.

FTSE EPRA/NAREIT Developed Index Bloomberg Barclays Global Aggregate Index MSCI World Index

Annual Growth in Dividends Per Share – FTSE EPRA/NAREIT Developed Index U.S. CPI

3


E X H I B I T 3 : T H E I N F L AT I O N S E N S I T I V I T Y O F G L O B A L R E A L E S TAT E S E C U R I T I E S V S . G L O B A L E Q U I T I E S A N D G L O B A L B O N D S

E X H I B I T 4 : C O N S T R A I N E D E F F I C I E N T F R O N T I E R W I T H 1 0 % G L O B A L R E A L E S T A T E S E C U R I T I E S : J A N U A R Y 1 , 2 0 0 0 - S E P T E M B E R 3 0 , 2 0 1 8

As of December 31, 2017. Source: Bloomberg. Global Real Estate Securities are represented by the S&P Developed REIT Index from January 2000 through February 2005 and the FTSE EPRA/NAREIT Developed Index thereafter. See index definitions at the end of this report.

As of September 2018. Source: Bloomberg. Global stocks represented by the MSCI World Index. Global real estate securities represented by the S&P Developed REIT Index from January 2000 through February 2005 and the FTSE EPRA/NAREIT Developed Index thereafter. Global bonds represented by the Bloomberg Barclays Global Aggregate Index. This model includes a 10% allocation to global real estate securities with varying percentages of global stocks and bonds. See index definitions at the end of this report.

A POTENTIAL HEDGE AGAINST INFLATION The pricing power of global real estate securities (discussed above) can be illustrated with a longer-term look at the performance of the asset class in periods of above-average inflation. Notably, in these periods global real estate securities have generated historical returns that were higher than both global equities and bonds.

Even though inflation remains relatively low by historical standards, we maintain that hedging an investment portfolio against the erosive impact of inflation is an important long-term investment consideration. History shows that real estate has exhibited a positive sensitivity to inflation, based on its absolute performance, as well as its relative performance to both global equities and bonds. Exhibit 3 compares the annualized returns of global real estate securities, global stocks and global bonds in calendar years with above-average inflation since 2000.

A S O U R C E O F A S S E T C L A S S D I V E R S I F I C A T I O NWe believe that adding global real estate securities to a portfolio of stocks and bonds offers diversification benefits that may serve to enhance portfolio efficiency. We illustrate this view with an analysis that compares the historical returns of portfolios with a varying mix of global equities and fixed income, both with and without a fixed 10% allocation to global real estate securities.

One contributing factor to these results is the moderate correlations observed between global real estate securities and traditional stock and bond investments, now about 0.46 on a trailing-12-months basis versus global stocks and 0.36 versus global bonds. As highlighted in Exhibit 5, these correlations are much lower than the long-term average for the asset class over multiple market cycles, from 2000-2018. We believe that combining moderately correlated asset classes can lead to broader diversification and enhanced portfolio efficiency.

0.0%2.0%4.0%6.0%8.0%

10.0%12.0%14.0%16.0%18.0%

Global BondsGlobal EquitiesGlobal Real Estate

6.5%4.8%

16.5%

4.0%

4.2%

4.4%

4.6%

4.8%

5.0%

5.2%

5.4%

5.6%

5.8%

0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% 14.0% 16.0% 18.0%

Ann

ualiz

ed R

etur

ns

Standard Deviation

Mix of Global Equities and Bonds 10% REITs with mix of Global Equities and Bonds

100% Equities

100% Bonds

50% Equities 50% Bonds

10% Real Estate 90% Bonds

10% Real Estate 90% Equities10% Real Estate

45% Equities45% Bonds

IN CALENDAR-YEAR PERIODS OF ABOVE-AVERAGE INFLATION OVER MULTIPLE MARKET CYCLES FROM 2000 THROUGH 2017, GLOBAL REAL ESTATE SECURITIES MEANINGFULLY OUTPERFORMED BOTH GLOBAL STOCKS AND BONDS.

4


M O R E T I M E LY I N V E S T M E N T C O N S I D E R A T I O N S A N D C U R R E N T M A R K E T O B S E R V A T I O N S

ATTRACTIVE DIVIDEND YIELDSAs noted earlier, the current yield of global real estate securities is 4.1%, compared with 2.4% for global equities and 2.2% for global bonds. Additionally, income generated by global real estate securities has maintained a healthy spread over the yields of global bonds, as highlighted in Exhibit 6. Today, the spread of 2.0% remains well above the historical average of 1.4% over the life of the FTSE EPRA/NAREIT Developed Index.

As of September 30, 2018. Source: Bloomberg. Global equities represented by the MSCI World Index. Global real estate securities represented by the S&P Developed REIT Index from January 2000 through February 2005 and the FTSE EPRA/NAREIT thereafter. Global bonds represented by the Bloomberg Barclays Global Aggregate Index. See index definitions at the end of this report.

As of September 2018. Source: Bloomberg. Global real estate securities represented by the FTSE EPRA/NAREIT Developed Index. Global bonds represented by the Bloomberg Barclays Global Aggregate Index. See index definitions at the end of this report.0.00%

2.00%

4.00%

6.00%

8.00%

Sep2018

Sep2017

Sep2016

Sep2015

Sep2014

Sep2013

Sep2012

Sep2011

Sep2010

Sep2009

Sep2008

Sep2007

Sep2006

Mar2006

CURRENT DIVIDEND YIELD OF GLOBAL REITS: 4.1%CURENT SPREAD TO GLOBAL BOND YIELDS: 2.0%

HISTORICAL AVERAGE SPREAD: 1.4%

E X H I B I T 6 : T H E S P R E A D B E T W E E N G L O B A L R E A L E S T A T E S E C U R I T I E S D I V I D E N D Y I E L D S A N D G L O B A L B O N D Y I E L D S R E M A I N S A T T R A C T I V E

E X H I B I T 5 : C O R R E L A T I O N S O F G L O B A L R E I T S T O G L O B A L E Q U I T I E S A N D G L O B A L B O N D S A R E M O D E R A T E

Global REITs Global Bonds

0.0

0.2

0.4

0.6

0.8

1.0

One-Year2000-2018One-Year2000-2018

0.46

0.73

Correlations with Global Equities Correlations with Global Bonds

0.360.44

Corr

elat

ion

N E A R - T E R M P E R F O R M A N C E T R E N D S A N D I N D U S T R Y F U N D A M E N T A L SReal estate securities have lagged broader equities in recent years. In our view, a significant factor driving this relative underperformance has been concerns around higher interest rates, as U.S. Treasury yields have more than doubled to levels in line with their 15-year averages. In our view, the extent of these moves so far suggests that the risks of rising rates have largely been priced into the market. Additionally, our research suggests that improvements made to balance sheets over the past 10 years may decrease the risk associated with rising rates.

5


VALUATION CONSIDERATIONS ACROSS SECTORS AND REGIONSIn terms of valuations, global real estate securities overall trade at a moderate discount to NAV. Simply stated, the value of publicly traded real estate securities is cheaper than the estimated value of the underlying real estate. As shown in Exhibit 7 below, the current global discount to NAV is about 700 basis points below its historical average from January 2000 through September 2018.vii

That said, dispersions in valuations exist across geographies and sectors based on real estate fundamentals within specific markets. Outlined below are two examples of opportunities we believe may be poised for stronger relative returns, based on our bottom-up investment analysis of market fundamentals and real estate securities valuations.

U.S. WEST COAST OFFICE PROPERTIES (PARTICULARLY SAN FRANCISCO)As technology companies have expanded beyond Silicon Valley, demand for San Francisco office space has been very strong. Additionally, the city has seen expansions from companies in the life sciences industry (biotechnology, pharmaceuticals, etc.), which may spur additional job growth.

New supply is limited, as San Francisco’s Proposition M (“Prop M,” passed in 1986 to prevent boom/bust real estate cycles) limits the amount of office development—950,000 gross square feet (gsf)—that can be approved every year.viii Each October, a fixed amount of square footage for office development potential comes available in the city. Office space not allocated in a given year carries over to subsequent periods.

Although a wave of new supply was delivered in 2018, Prop M will limit the amount of new construction that takes place over the next few years. As of this writing, there is currently 3.8 million gsf available for allocation. However, that compares with 9.2 million gsf of pending projects in the Prop M pipeline awaiting allocation.ix This is likely to result in a shortage of new supply relative to the strong demand in the market. With strong demand drivers and very limited new supply, vacancy rates have declined and rent growth has been strong. We expect this trend to continue if this imbalance persists.

Our research shows that, in addition to these positive fundamentals, REITs focused in U.S. West Coast markets (with exposure to San Francisco) have recently traded at attractive discounts relative to peers in other markets—in terms of both valuation multiples and discounts to NAV.

As of September 30, 2018. Represents data beginning January 2000. Sources: UBS Global Real Estate Research; Brookfield Investment Management research and estimates. See index definitions at the end of this report.

-50%

-40%

-30%

-20%

-10%

0%

10%

20%

30%

Sep2018

Sep2017

Sep2016

Sep2015

Sep2014

Sep2013

Sep2012

Sep2011

Sep2010

Sep2009

Sep2008

Sep2007

Sep2006

Sep2005

Sep2004

Sep2003

Sep2002

Sep2001

Sep2000

Jan2000

AVERAGEPREMIUM/DISCOUNT

TO NAV

E X H I B I T 7 : G L O B A L R E A L E S T A T E S E C U R I T I E S P R E M I U M / D I S C O U N T T O N A V : S E P T E M B E R 2 0 0 0 – S E P T E M B E R 2 0 1 8

6


IMPORTANT DISCLOSURES Brookfield Investment Management Inc. (the “Firm”) is a wholly-owned subsidiary of Brookfield Asset Management Inc. Opinions expressed herein are current opinions of the Firm, including its subsidiaries and affiliates, and are subject to change without notice. The Firm, including its subsidiaries and affiliates, assumes no responsibility to update such information or to notify client of any changes. Any outlooks, forecasts or portfolio weightings presented herein are as of the date appearing on this material only and are also subject to change without notice. Past performance is not indicative of future performance, and the value of investments and the income derived from those investments can fluctuate. Future returns are not guaranteed, and a loss of principal may occur. The information in this publication is not, and is not intended as, investment advice, an indication of trading intent or holdings or the prediction of investment performance. Views and information expressed herein are subject to change at any time. Brookfield disclaims any responsibility to update such views and/or information. This information is deemed to be from reliable sources; however, Brookfield does not warrant its completeness or accuracy. This presentation is not intended to constitute, and it does not constitute, an offer or solicitation to sell or a solicitation of an offer to buy any security, product, investment advice or service (nor shall any security, product, investment advice or service be offered or sold) in any jurisdiction in which Brookfield is not licensed to conduct business, and/or where an offer, solicitation, purchase or sale would be unavailable or unlawful.Performance shown in USD unless otherwise noted. Past performance is not indicative of future results.

I N D E X D E F I N I T I O N S The Bloomberg Barclays Global Aggregate Index is a market capitalization-weighted index comprising globally traded investment-grade bonds. The index includes government securities, mortgage-backed securities, asset-backed

securities and corporate securities to simulate the universe of bonds in the market. The maturities of the bonds in the index are more than one year.The FTSE EPRA/NAREIT Developed Index is an unmanaged market capitalization-weighted total-return index that consists of publicly traded equity REITs and listed property companies from developed markets.The MSCI World Index is a free float-adjusted market capitalization-weighted index that is designed to measure the equity market performance of developed markets.The S&P Developed REIT Index serves as a comprehensive benchmark of publicly traded equity REITs domiciled in developed markets, with a launch date of December 31, 1992.These indexes do not reflect any fees, expenses or sales charges. Indexes are not managed and investors cannot invest directly in an index. Index performance is shown for illustrative purposes only and does not predict or depict the performance of any investment.©2018 Brookfield Investment Management Inc. is an SEC-registered investment adviser and represents the Public Securities Group (“BIM-PSG”) of Brookfield Asset Management Inc., providing global listed real assets strategies including real estate equities, infrastructure equities, multi-strategy real asset solutions and real asset debt. BIM-PSG manages separate accounts, registered funds and opportunistic strategies for institutional and individual clients, including financial institutions, public and private pension plans, insurance companies, endowments and foundations, sovereign wealth funds and high-net-worth investors. BIM-PSG is an indirect, wholly-owned subsidiary of Brookfield Asset Management, Inc., a leading global alternative asset manager with approximately $330 billion of assets under management as of September 30, 2018. PSG manages nearly $19 billion of assets as of September 30, 2018.

JAPANESE DEVELOPERSAnother example of a current investment opportunity is in Japan, where we believe Japanese developers present attractive valuations on an absolute basis and relative to their J-REIT counterparts. We specifically like developers focused on the Tokyo office market, as demand is strong for new office buildings, evidenced by a more than 7% increase in Tokyo office rents over the past year.X

In addition to positive fundamentals, Tokyo developers are trading at a discount to NAV not seen since 2011. In contrast, J-REITs trade much closer to their long-term premium to NAV.xi

O U R C L O S I N G P E R S P E C T I V E We consider global real estate securities to be an attractive source of income, insulation from inflation and asset class diversification for traditional stock and bond investors. While global real estate securities are currently trading below historical averages overall, we continue to see attractive valuations across many of the sectors and geographies of our universe. Two of these segments were highlighted in this summary: U.S. West Coast office properties and Japanese developers.

One of the common concerns we hear from investors is the negative impact of interest rate hikes on global real estate returns. History shows that these securities often react negatively in the short run to the initial upward move in interest rates; however, over longer periods of time, the positive effects of economic growth have generally counteracted the effects of higher rates over time. Based on where we see valuations, and the meaningful moves made so far to normalize U.S. interest rates, our view is that much of this cycle’s risk from rising rates has already been priced into the market.

Outside of the U.S., monetary policy has been much more accommodative, as economic growth trends have been muted. While this type of regional decoupling has its challenges, our view is that it has also opened opportunities for active managers with specialized real estate expertise. Importantly, a bottom-up selection process is key, as not all global real estate companies are created equally in terms of management quality and balance-sheet strength, while the valuations of companies, sectors and geographies also vary greatly. Our focus is on identifying attractively priced global real estate companies, while considering the many differences in market fundamentals and security pricing.

7


E N D N O T E S :i. PSG, or Brookfield Investment Management Inc., is a wholly-owned

subsidiary of Brookfield Asset Management Inc.ii. See detail in Exhibit 3iii. See detail in Exhibit 4iv. Source: Bloomberg as of September 30, 2018v. Source: Bloomberg as of September 30, ,2018vi. Source: Bloomberg as of September 30, 2018vii. Source: UBS as of September 30, 2018viii. Enacted November 4, 1986ix. Last updated October 19, 2018; http://zasfplan.sfplanning.org/ANLM/Office_

Allocation_Stats.pdf x. Source: Miki Shojixi. Source: Brookfield Investment Management research

C O N T A C T U STelephone: 1-855-777-8001 Email: [email protected] Or visit our website at www.brookfield.com © 2018 BROOKFIELD INVESTMENT MANAGEMENT INC.

a case for allocating to global real estate securities/media/files/b/...publi securities roup i 4...

Documents