The first quarter of 2021 saw an acceleration of the post-COVID-19 economic recovery. We believe this activity was largely a result of the unprecedented levels of monetary and fiscal stimulus announced and injected into the financial and real economy, but was also due to vaccine rollouts.
As the year progressed, Bloomberg Consensus estimates for global and US economic growth were raised. In kind, inflation expectations increased and, mid-quarter, was, in our opinion, the catalyst for a pullback in risk assets as bond yields rose from extremely low levels.
We remain watchful for rising inflation pressures, but for the time being, believe that the major driver of an increase in inflation will be a recovery on very depressed year-on-year numbers.
With this macro background, “re-opening” and “reflation” themes dominated the equity and REIT markets in our opinion. This caused a substantial repricing in value-oriented REITs relative to growth REITs around the world, particularly in the hotel and retail sectors.
FTSE EPRA/NAREIT DEVELOPED RETURNS IN USD AS OF 3/31/21
In the US, the mall sector’s return gained around a third during the quarter, significantly outperforming the benchmark after a challenging 2020. Additionally, the strip retail and hotel sectors were meaningful outperformers during the quarter delivering relative outperformance.
Domestic travel has intensified through spring break with some resort destinations seeing room rates above 2019 levels
In our 2021 outlook piece published earlier in the year, we highlighted our expectation that strip retail and hotel names outperform, and a reversal in stock performance of more value-oriented names. However, given the post-COVID-19 uncertainty around enclosed malls and the lack of demand for the asset type, we had not anticipated the strong performance from the mall stocks to start the year.
On the other hand, our positive outlook on both hotels and strip center retail has proven to be conservative. According to hotel operators, domestic travel has intensified through spring break with some resort destinations seeing room rates above 2019 levels. The strengthening consumer sector has created robust demand resulting in an almost inelastic demand source for high quality resorts. Additionally, we have witnessed an uptick in business transient demand, much sooner than we had previously anticipated and group demand has accelerated with the expectation for a strong back half of 2021. According to our own analysis, all three legs of the hotel demand stool seem to display strong pent up demand that will likely result in EBITDA levels reaching 2019 much sooner than the market is anticipating.
For the strip center retail sector, the anecdotes of leasing demand entering the space have broadened. According to company management, the sector is benefitting from the household formation in suburban locations generating strong demand for the storefront. Additionally, tenants have enhanced their omnichannel strategy and are more effectively utilizing their store footprint to accommodate in person shopping as well as online delivery/pickup.
Our contrarian bearish call on the tech-oriented sectors proved correct. Despite record high valuations as a result of the pandemic, we expected the growth forecasts to disappoint meaningfully. This expectation resulted in a substantial underweight in the portfolio that strongly contributed to the quarterly performance. Upon the realization of this catalyst and the expected underperformance, we re-entered the sector in early March. Our research has identified a pullback in investor expectations allowing for an attractive entry point and potential positive surprises.
In our opinion, work–from-home arrangements continue to cast uncertainty over the US office sector, evidenced by persistent share price underperformance and discounts to estimates of net asset value.
According to a recent JLL survey, 66% of office workers prefer a flexible work arrangement, resulting in a 24% reduction to days in the office. However, the forecasting uncertainty lies in tenant leadership policy of balancing flexible work arrangements with maintaining culture and collaboration, as well as in flexible work office space planning, such as employee willingness to share desks and the degree of increased collaboration space. From what we observe, the lack of transactions of Class A multi-tenant, mixed lease term assets further cements this uncertainty. While work-from-home arrangements will likely reduce demand, we think that the likely “flight to quality” on tenants seeking high amenity and public transit-oriented Class A assets should insulate the majority of REIT portfolios.
In Europe, we believe that the rapid vaccine rollout in the UK has contributed to it outperforming the continent. Similarly, the re-opening trade has proved strong with retail stocks generating strong YTD performance.
The rapid vaccine rollout in the UK has contributed to it meaningfully outperforming the continent
Surprisingly however, UK student housing stocks have not rallied. While company management has offered concessions to allow students the flexibility to not pay rent on unoccupied units, we see this as a short-term issue as forward bookings for the fall semester remain robust and as such, the sector is, in our opinion, mispriced.
In Europe, quarterly performance was more mixed than any other region. Despite the re-opening trade largely benefitting the depressed office sector despite the work-from-home risk, shares of listed continental European office names did not re-rate. This is surprising as, in our opinion, continental European office fundamentals remain resilient and present limited downside risks relative to expectations. In addition, there have been several M&A bids from private equity, high net worth and listed peers displaying better private market valuation expectations than what is currently implied by the public markets. In addition, we have witnessed several M&A bids from private equity, high net worth, and listed peers displaying higher private market valuation expectations than what is currently implied by the public markets. We continue to see the mid-term outlook as resilient to improving and expect the current discounted valuation to diminish.
In Asia, Japan outperformed the rest of the region. Similar to the other regions, Asia-Pacific has seen a strong reversal in value oriented names. Our expectation is that the re-opening trade in Asia-Pacific has largely run its course with investor focus expected to shift towards niche property sectors with strong secular growth. We continue to remain bullish on the Australian residential sector and believe the recent inflationary fears impacting the housing market are largely unjustified. Additionally, after the retracement of tech real estate stocks, we deployed capital into the data center sector.
We remain bullish on the Australian residential sectors
In Japan, we continue to be bullish on the re-opening prospects largely expressed through the hotel J-REITs and developers. With the expectation for domestic travel to accelerate in conjunction with the vaccine rollout, we believe the dividend yield gap for the sector remains too wide. We expect this to compress over the near-to-medium term potentially resulting in significant outperformance going forward. In addition, we believe the re-opening trade benefits the Japan developers. Throughout the pandemic, the office exposure present within the developers was highly resilient realizing limited COVID impact. We think that a return to “normal” should help boost their development pipeline as growth expectations begin to increase.
At the end of March, the global REIT market was trading at a 3.3% dividend yield, implied capitalization rate of 4.9% and a premium to net asset value of 2.6%. Similarly, the US REIT sector was trading at a 3.4% yield, 5.2% capitalization rate, and an 10.4% premium to net asset value. Both markets are trading at a wide spread to sovereign bonds and corporate credit yields and while the market has broadly viewed the re-opening trade with a broad brush, we anticipate a distinguishing between cyclical and secular growth which will support the need for ongoing active management of REIT portfolios.
- Past performance is no guarantee of future results.
- The views and opinions in the preceding Commentary are as of the date of publication and are subject to change.
- There is no guarantee that any market forecast set forth in this presentation will be realized.
- This material should not be relied upon as investment advice, does not constitute a recommendation to buy or sell a security or other investment and is not intended to predict or depict performance of any investment.
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