Insight

Global best ideas in real estate

Global best ideas in real estate

As part of the recent Invesco Asia Pacific Forum, Calvin Chou, Bert Crouch, and Andy Rofe, from Invesco’s Real Estate team spoke with Simon Redman, Managing Director, Client Portfolio Management, on their best ideas in real estate and where they see value in Asia Pacific, North America and Europe. Below are some excerpts from this insightful session. 

Q: Calvin, what are some of the best ideas in real estate coming out of the Asia Pacific region?

Chou: We remain positive on Japan. It is an outlier opportunity as we think about global markets and a clear Covid winner in terms of how the macroeconomy has performed. Japan's exports, manufacturing and consumer goods boomed during the pandemic period. When you juxtapose that with the restrictive Covid border that stemmed capital flow into the country, we believe that from a relative real estate valuation perspective, it is a fundamentally sound market.

Japan is also an outlier in terms of where liquidity stands today. Thinking about the real estate industry and positive spreads, it's probably the only developed market in the world today that can deliver positive carry on real estate. Our ability to borrow in Japan remains accessible and that liquidity and positive yield is unique. This is one of the fundamental reasons why we still see capital flowing to this market.

Q: Which specific sectors do you find most compelling?

Chou: Ultimately as we dive into opportunities, logistics remains top of our list. This market is probably the most fundamentally sound from a supply-demand standpoint. Only one-third of the logistics stock in Japan was built in the last decade, much of the existing stock is quite antiquated. In terms of specific opportunities, an area where we've been extremely focused is cold storage and cold chain logistics. This is an end of the segment that has been underinvested in recent times. We see very strong demand as the major cities are operating at near full utilization. This gives us confidence in our ability to deliver product at yields that are unique compared to other markets.

For example, we made an investment in a cold logistics property on the east side of Tokyo last year and stabilized that asset at a gross yield of close to 4%. We obtained a loan on that opportunity back in September 2022 at an all-in cost of about ~90 basis points at 70% LTV. I think globally in the Q3 to Q4 period, to get a loan at that type of pricing and loan-to-value (LTV) was probably impossible in any other market. This type of cash-on-cash yield is difficult to challenge globally on a risk adjusted basis.

Figure 1 – Japan cold logistics property
Figure 1 – Japan cold logistics property

Source: Invesco, for illustrative purposes only. Note: Photographs are included for illustrative purposes only and are used with permission, do not constitute investment advice or a recommendation. There can be no assurance that stated objectives will be realized. Past performance is not a guide to future results.

We believe Japan is going to continue to be one of the winners coming out of this economic cycle. While inflation remains a welcome target, we expect the government to continue to keep interest rates near current levels. Wages and consumption data remain positive. There’s increasing debate on where the yield curve will go, and as we look at the forward swaps, the pricing  remains far below 100 basis points. As we look acrossmarkets where it's quite difficult to manage bid-ask spreads, Japan is still a safe place to swim in a turbulent time.

Q: Bert, how does the APAC macroeconomic landscape contrast to North America?

Crouch: It is ironic that we started in Asia Pacific because when you think about the opportunity set relative to the United States or broader North America, it's very different. Where the APAC region is seeing accretive interest rates in some markets, here we're seeing the opposite coming out of Covid.

The Fed’s unprecedented fiscal and monetary stimulus from the pandemic injected money supply into the economy and ultimately drove inflation upward. The Fed had to combat that via, again, an unprecedented increase in interest rates. As a result, the Fed funds rate has increased over 500 basis points in only 15 months1 and accordingly has sent our broader interest rate environment to a level that we haven't seen in a significant period.

Q: What does that mean for the opportunity set and best ideas in the U.S.?

Crouch: Counterintuitively one of the best opportunities we're seeing today is not actually in investing in underlying real estate but lending against it.

I'd argue that the broader capital markets in the U.S. are dislocated and becoming worse. The significant increase in interest rates resulted in more volatility in fixed income markets and led to a banking crisis in March. We had Silicon Valley Bank fail and then ultimately three other banks followed suit in a period of 30 or 45 days. This significantly increased credit spreads on top of the increases in underlying interest rates. Moreover, we've seen that inflation is even stickier than most have predicted. The forward curve of the secured overnight financing rate, better known as SOFR, has become steeper and stayed higher for longer just in the last 90 days

Q: Why is this capital market dislocation so unusual on a historical basis?

Crouch: During the global financial crisis, we had the inverse. We had spreads widen but then the Federal Reserve combatted that by significantly lowering interest rates to juice demand. This time we have the opposite, so we have the best of both worlds from a credit standpoint. We have a high base rate of SOFR at north of 5% and historically wide credit spreads north of 3%. So, we are typically seeing unlevered credit yields north of 8.5%.

So how does this compare to the returns that I can get by investing in real estate? It is important to lend wisely. We are lending at a 30 to 35% discount to today's values, that's over a 50% discount to peak values. So capital preservation is high. Also, net asset value (NAV) stability is consistent as the Sharpe ratio of real estate credit has historically been high. The NAV doesn't differ much in relation to return thus looking attractive on a risk-adjusted basis. We're seeing the same high-quality sponsorship and collateral that we've lent out in the past. We're just able to do it with wider credit spreads, lower LTVs, and a tighter covenant structure.

Q: What does that mean for the return profile overall?

Crouch: What we're able to do is carve out a subordinate piece of the capital structure and take that 8% unlevered return to a return with current income north of 11% and total return in the low teens. Finally, the portfolio fit is desirable. The correlation of real estate credit to equity and the correlation to other fixed income asset classes is very low. We’re also seeing unusually low historic loss ratios. We do have some outliers in sectors like office, but with a de novo portfolio going forward, this obviously would not be a part of it.

Overall, the portfolio fit, current income, total return, and perhaps most importantly in today's environment, capital preservation, are all unusually attractive in the North America commercial real estate credit opportunity set.

Figure 2 – New York multifamily property (whole loan)
Figure 2 – New York multifamily property (whole loan)

Source: Invesco, for illustrative purposes only. Note: Photographs are included for illustrative purposes only and are used with permission, do not constitute investment advice or a recommendation. There can be no assurance that stated objectives will be realized. Past performance is not a guide to future results.

Q: Andy, how does Europe differ? Could you share what ideas you are seeing these days?  

Rofe: I think the fundamentals in Europe are relatively healthy. Over the past 15 months, markets have repriced around 100 basis points across all sectors.2 The capitalization rates have also stabilized which provides pricing points in the market and enables transactions to happen. Supply remains constrained and demand is healthy across most sectors and markets. Financing rates in the UK and Europe going forward have stabilized which provides scope to price investment opportunities in the region.

On the real estate credit opportunity in Europe, risk adjusted returns are at record levels. Margins are at 10-year highs and LTV ratios are at 10-year lows. As valuations in Europe have adjusted quickly, this provides confidence in lending levels.

While banks dominate the lending scene in Europe, they are taking on a risk-off approach. This provides a gap and an opportunity to invest. If you take a property-first approach, focussing on the asset’s business plans, adopting a low risk tolerance and factoring in ESG factors, we believe there are compelling opportunities.

Q: Could you share an example of a recent credit opportunity? How about equity?

Rofe: One opportunity which we completed in the last three months was in the self-storage sector in the UK. It was a loan with a margin of 430 basis points above the Sterling Overnight Interbank Average (SONIA), a floating rate to hedge against inflation and the likely unlevered return profile north of 9% which is similar to the figures Bert mentioned in the US.

In terms of equity, we see a vintage opportunity in the high-returning sector within the equity stack. These can be accessed with repositioning opportunities on existing assets and off-market recapitalization opportunities. We’re looking at some very interesting examples in both the logistics and residential multifamily sectors and are also targeting opportunities arising from the stress in the market.

One example is a logistics development opportunity we recently purchased in Northern Italy, which is a very prosperous region in Europe. The pricing of that as a reference point was about a 40% discount to the asking price back in early 2022. At the same time there’s an acute undersupply with 1.7% vacancy in that locality. This provides a return profile north of 20% given the attractive entry price and the healthy fundamentals underpinning this opportunity.

Figure 3 - Italy logistics development property
Figure 3 - Italy logistics development property

Source: Invesco, for illustrative purposes only. Note: Photographs are included for illustrative purposes only and are used with permission, do not constitute investment advice or a recommendation. There can be no assurance that stated objectives will be realized. Past performance is not a guide to future results.

Historically, forward investment returns have always been strongest for vintage years coming out of a market correction. Thus, we anticipate 2024 to be as strong as 2014 was in terms of a post-cycle recovery opportunity set.

Footnotes

  • 1

    Two Charts Highlighting the Shifting Interest Rate Situation, June 2023, https://aei.ag/2023/06/19/charts-shifting-interest-rates/

  • 2

    CBRE, data as of April 2023, accessed via: https://www.barings.com/globalassets/2-assets/perspectives/viewpoints/quarterly/2023/05-may/eur-real-estate-quarterly_1q2023.pdf

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