Current valuations suggest global listed property should outperform direct real estate over the next five years, according to a new AMP Capital Investor study.
The AMP Capital white paper, titled ‘Don’t tell me it’s not real estate’, says historically there has been a strong link between listed property pricing (using the US as a proxy) and future performance in the direct real estate market.
“… if we look at listed real estate in the US since 1988, whenever prices have been at a premium to NAV [net asset value], direct real estate appreciated 96% of the time in the following 12 months,” the report says.
“Yet in times of discount, listed real estate has nearly always delivered greater five-year returns than direct.”
The study, authored by AMP Capital co-head of global listed real estate, James Maydew, found on average the international listed property market was trading at a 14 per cent discount to NAV “implying the market believes some parts of the direct market have become overheated for the time being”.
“Utilising the above analysis and assuming it holds…, listed real estate should deliver superior performance in the next five years over direct and would enhance a portfolio that only has direct,” the paper says. “…As a real estate investor, you may well benefit from allocating funds to listed and direct real estate, and arbitraging between the two.”
As at February this year a range of countries in Asia – including Hong Kong, Singapore and India – saw the largest listed property discounts to NAV with the UK and US markets trading at a discount of -21.5 per cent and -2.6 per cent respectively.
The US$4.4 billion New Zealand real estate investment trust (REIT) market was trading at a 10.6 per cent premium, the AMP Capital research shows. Australian REITs were almost at NAV, trading at just a 0.1 per cent premium.
Meanwhile, with the exception of the hotel sector, which was at a 31.1 per cent premium, all listed real estate sectors were discounted, ranging from -3.1 per cent for industrial to -29 per cent in the diversified market.
“In individual markets where listed property is trading at a discount to NAV, the best management teams are taking advantage of strong pricing in direct property markets, selling non-core assets and utilising the proceeds to either de-lever balance sheets or shrink their equity base by returning capital to investors,” Maydew said in a statement.
However, the report says pension funds globally were significantly underweight listed property compared to direct.
“But the very fact listed real estate still makes up only a small fraction (12-13%) of total real estate investment allocation by pension funds globally suggests many are missing this opportunity,” the study says.
According to the report, listed real estate accounts for just under 1 per cent of all global pension fund assets.
The study says pension funds’ “over-reliance on short-term data” probably explains the relative unpopularity of listed property.
However, after adjusting for “smoothing in direct valuations, leverage and portfolio composition”, the volatility gap between listed and direct property narrows considerably.
“In fact the biggest myth debunked in this analysis is that direct real estate is not volatile. Pedersen et al (2012) report that, after correcting for smoothing, the volatility of direct real estate is actually about 2.5 times higher than implied by unadjusted volatility estimates,” the AMP Capital report says.
At the same time, the paper cites several studies showing US listed property outperforms direct real estate over the long-term.
A CEM Benchmarking analysis of the US defined benefit funds asset class performance over 1998 to 2011 “found US listed real estate recorded an average annual net return of 11.31%, the highest average annual net return of any asset class over the sample period,” the AMP Capital report says.
“Direct real estate investments trailed REITs by 3.7% per year due to their significantly lower gross returns as well as direct’s relatively high investment costs, but still outperformed US large cap equities by 1.55% per annum after fees.”
Nonetheless, the white paper says the distinction between direct and listed real estate becomes less noticeable over time.
“Over the longer term, direct real estate and listed real estate prices are highly correlated to each other but lowly correlated to equities over a five-year period,” AMP Capital says. “The correlation moves from around 0.05 after one month, but settles at around 0.85 after five years, proving they are interchangeable over the long term.”