Trips Around the World
Zenouzi warns investors looking globally not to be seduced by red-hot growth figures, like China's 7.5% annual clip. "Don't be fooled by [the idea that] higher GDP means higher total return. That's completely untrue," Zenouzi says. He notes that from 2010 to 2011, Singapore and China had higher GDP growth than the United States, but much tighter credit conditions. While the United States was stumbling through an anemic recovery, U.S. REITs still outperformed their Asian brethren handily in those years because the Fed had turned on the liquidity spout. Now, as credit conditions are easier in China, the tables are turning and those real estate companies are doing well.
Still, Zenouzi is cautious on the region. He notes that Hong Kong residential prices have passed their 1997 peak, and local authorities are starting to manage the market in Hong Kong and Singapore by adding inventory to slow price inflation and placing restrictions on the market. He holds no pure residential developers in the region and has cut back his portfolio's exposure to more diversified real estate developers such as Keppel Land and CapitaLand.
Zenouzi says Japan is at a crossroads, with a new government coming to power, and expected quantitative easing raising the possibility that policy changes could spur the market. Although investors have been calling a bottom to Japan's slide for 20 years, there are some facts in its favor. Land prices are finally back to where they were in 1981, 60% off the peak in 1990. With inflation rates now above zero, investors are starting to believe that the end of deflation is at hand, which is a good setting for hard assets like property. The markets have responded, with the Japanese real estate sector climbing about 35% for the year in U.S. dollar terms by mid-December, compared with 4% for the broader market.
Reforms to the Japanese REIT market are on the table, which would allow the companies to enter into overseas transactions. "It could be the best thing in 20 years," says Zenouzi, who notes that despite its slump of more than a decade, Japan is still the world's second-biggest economy. Ferguson is also enthusiastic, particularly about seeing improvement in Tokyo's central business district. His picks include Mitsui Fudosan and Mitsubishi Estate.
Both Zenouzi and Ferguson are cautious on Europe, citing the region's weak financial state. Zenouzi says the quality of the companies is also worrying.
"You only want to own core properties in Europe [London, Paris, Berlin], not secondary and tertiary cities, because the quality of companies' balance sheet growth is not as good as the United States or companies in Asia," Zenouzi says. Unibail-Rodamco, the French firm, gets his nod of approval as the owner of some of the best retail properties in Europe.
What's more, prices for properties in secondary and tertiary cities could be hurt as banks in Spain and elsewhere are forced to sell off their foreclosed assets—most likely to private equity and hedge fund investors. Zenouzi notes that European banks hold about $2 trillion worth of real estate loans, most of which have not yet been marked down to their market value.
In the United States, Zenouzi admits that much good news has been reflected in the share prices. He reckons valuations are at 8% to 9% premiums to net asset value. "Fundamentals need to catch up to valuations," he says. As long as credit stays healthy, Zenouzi says, the stocks can continue to post "decent returns."
On a sector level, some of the best performers have been self-storage REITs. They have prospered on demand growth, and the bigger public companies are taking market share from smaller privately held companies through sophisticated marketing and online platforms. They are winning customers with clever ad searches on Google, says Jason Yablon, a portfolio manager at real estate specialist Cohen & Steers.
Self-storage leaders like Extra Space, with stock that rose around 45% last year, have capitalized on technology to gain occupancy and push rental rates higher on existing tenants, scoring healthy same-store revenue with little expense growth. The company has done so well it's been able to buy out some of its joint venture partners and buy new properties. Its secret is being more aggressive on pricing than smaller privately held competitors.
"The company is trying to market to people who'll stay longer and can handle the price increases," Yablon says. "Do you give the discount to the college kid or the homebuilder who needs to store his drywall? The construction guy will be there for the next five years, so I can raise his rent in the next three months by a bit."