ING Investment Management says real estate is likely to underperform equity markets in the current environment of rising long-term rates. However, it says this doesn’t necessarily make the asset class unattractive and it remains overweight in it.
This is because it believes dividend yields remain attractive versus bond yields and are above those in equity markets. Also, from a historical perspective, it says a buffer of extra yield from listed real estate versus corporate bond yields has been built-up, thereby mitigating rising returns from the latter.
Koen Straetmans, senior strategist for real estate and commodities said that the performance of listed real estate relative to equity over the last three years has been tightly linked to the evolution of long-term interest rates in the developed world. Listed real estate is the more leveraged asset class, and with most debt at developed market real estate companies at fixed long term interest rates, the evolution of interest rates has been a good explanatory factor for the relative performance of real estate versus equity.
He added: “Recently, this relationship had been temporarily broken by severe systemic crisis stress that led to a disconnection with real estate clearly underperforming. Subsequently, two LTRO announcements in December 2011 and February of last year managed to abate these fears, simultaneously helping real estate to outperform as interest rates declined further. The relationship between interest rates and relative performance of listed real estate has been re-established.”
By the summer of last year, announcements of central banks around the world managed to further reduce the systemic tail risk. At the same time they also provided further support to the unfolding global economic recovery. In this environment, 10 year US Treasury yields rose, a trend that continued in the early part of 2013.
However, ING IM said the impact of interest rate movements on listed real estate performance differs across regions. US listed real estate and, to a lesser extent, UK listed real estate have the highest negative correlation since 2012 (at -0.63 and -0.49 respectively). This compares to a negative correlation of -0.45 for global listed real estate.
Developed Asian listed real estate has a lower correlation to US Treasury yields, as does real estate in the Eurozone and in emerging markets, in particular. The investment manager says lower leverage here compared to the US, is part of the reason for this.
Within listed real estate, ING IM is overweight in Developed Asian (Australia, Singapore, Hong Kong and Japan). It believes that Japanese listed real estate remains relatively attractive, despite last year’s outperformance and short term pressure linked to substantial new equity issuance.