By: Joe Rodriguez, Managing Director and Senior Portfolio Manager, Invesco Real Estate
Overall, the fundamentals of the global real estate market appear relatively strong, with investors driving strong performance with their search for yield, cash flow stability and cash flow growth. US real estate sectors and markets are experiencing an across-the-board recovery. Low supply of new commercial real estate construction has accelerated existing rental property income growth, aiding the real estate cycle. The multifamily sector, however, was an exception as new construction projects have increased.
Outside the US, Asian markets delivered the best results, led by strong share price performance in Japan, where monetary policy changes helped shape returns. Looking ahead in the US, we anticipate growth from improving occupancy rates and rents, and from REITs buying assets accretive to earnings.
Last quarter was positive in terms of total returns for both the global real estate securities market and the US real estate investment trust (REIT) market, which returned 6% and 8%, respectively.1
US real estate ETF flows were particularly strong in the first quarter, causing smaller-cap, higher-levered and generally lower-quality companies to outperform. The increase in real estate fund flows demonstrates the willingness of yield-searching investors for investments that offer, in addition to yield, cash flow stability and growth. For such investors, the REIT market has helped filled that void.
Europe is still experiencing a bifurcated market. While there are areas of European real estate that are slumping because of slow job growth, which has weakened tenant demand, other areas, such as west end of London and Germany, have seen tenant demand outpace supply.
Overall, better values exist in international markets than in the US. For example, at the end of the first quarter, discounts to underlying asset value remained in Continental Europe, the UK, Singapore and Hong Kong. Perceived safer markets, such as Japan and the US, appear to be trading at premiums to their net asset value.
We manage three distinct real estate securities strategies. Two of our strategies have a total return objective: One invests predominately in US equity REITs and the other in global real estate equities. Our third strategy has a primary objective of income and invests globally across the real estate capital structure, in real estate equities and real estate fixed income securities.
As fundamental real estate managers, we still believe that stock selection, as opposed to country or currency weights, offers the best opportunities. Therefore, our country weights are fairly equal to those of our benchmark index.
Overall, our total return strategies didn't have any significant deviations in either REIT sector weightings or country weightings relative to their respective benchmarks. We seek to outperform the benchmarks due to our stock selection, not market allocation. We believe this is especially important in our global total return strategy given global macroeconomic concerns.
In the first quarter, our US strategy underperformed the FTSE NAREIT All Equity REITs Index. The underperformance was partly due to the concentration of funds flowing into US REIT ETFs, which caused lower-quality, higher-yielding, smaller-cap companies to outperform during the quarter. Our investment process has a quality bias which precludes us from investing in lower quality companies. Instead, we prefer to invest in larger-cap companies with strong management teams improving market fundamentals and lower levels of leverage, as we believe these are the companies that are rewarded over the long term.
Our global total return strategy fared relatively better in the first quarter, with most international regions outperforming their benchmark counterparts.
Invesco Global Real Estate Income Fund reached a milestone this year, surpassing $1 billion in assets under management. The fund is currently fairly balanced between common stock and debt, yet retains the flexibility to adjust that weight to changing market conditions. We believe this fund offers the chance to participate in the returns of global real estate equities, with a level of protection from down real estate markets.
As we mentioned, the fundamentals of the real estate markets are strong, with some exceptions. Although the markets are continually reappraising risk and return requirements for all investment classes, in our view, real estate securities valuations currently appear fair by longer-term standards. We also believe yields are attractive compared to fixed income investments and other equity sectors.
The opinions expressed are those of the authors, are based on current market conditions as of April 2013 and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.
This does not constitute a recommendation of the suitability of any investment strategy for a particular investor.
The investment techniques and risk analysis used by the strategy may not produce the desired results.
Past performance cannot guarantee comparable future results.
The FTSE EPRA/NAREIT Developed Real Estate Index is an unmanaged index considered representative of global real estate companies and REITs. The FTSE NAREIT All Equity REITs Index is an unmanaged index considered representative of US REITs. An investment cannot be made directly in an index.
Invesco Advisers, Inc. is an investment advisor; it provides investment advisory services to individual and institutional clients and does not sell securities. Invesco Distributors, Inc. is the US distributor for Invesco's retail products. Each entity is a wholly owned, indirect subsidiary of Invesco Ltd.
Data as of March 31, 2013, unless otherwise stated.
Investments in real estate related instruments may be affected by economic, legal, or environmental factors that affect property values, rents or occupancies of real estate. Real estate companies, including REITs or similar structures, tend to be small and mid-cap companies and their shares may be more volatile and less liquid.
The investment techniques and risk analysis used by the portfolio managers may not produce the desired results.
The fund may hold illiquid securities that it may be unable to sell at the preferred time or price and could lose its entire investment in such securities.
Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa.
Junk bonds involve a greater risk of default or price changes due to changes in the issuer's credit quality. The values of junk bonds fluctuate more than those of high quality bonds and can decline significantly over short time periods.
Debt securities are affected by changing interest rates and changes in their effective maturities and credit quality.
The dollar value of foreign investments will be affected by changes in the exchange rates between the dollar and the currencies in which those investments are traded.
Credit risk refers to an issuer's ability to make timely payments of interest and principal. Because the fund generally invests only in investment grade-quality debt securities, it is subject to a lower level of credit risk than a fund investing in lower-quality securities.
To the extent the fund invests a greater amount in any one sector or industry, the fund's performance will depend to a greater extent on the overall condition of the sector or industry, and there is increased risk to the fund if conditions adversely affect that sector or industry.
Mortgage- and asset-backed securities are subject to prepayment or call risk, which is the risk that the borrower's payments may be received earlier or later than expected due to changes in prepayment rates on underlying loans. Securities may be prepaid at a price less than the original purchase value.
The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.