Looming shortages globally are driving property company share prices higher, while the property sector continues to benefit from sustained low interest rates and inflation.
"With central banks around the world flooding the market with capital and Asian markets already awash with liquidity, the property markets are well supported despite the sluggish economic backdrop. Moreover, high-quality property companies have access to debt capital at historically cheap levels. This environment is supportive of material gains from the property sector in 2013."
Three big concerns will fade
"The strong outperformance in 2012 of the property sector relative to the broader equity markets in both Europe and Asia is partly a recovery from weakness in 2011, but also may be reflective of the market’s expectation of rising valuations due to forthcoming supply shortages. In addition, there are several important trends developing that could lead to further demand for property and more upward pressure on rents and pricing in general. Firstly, Chinese economic data appears to be improving and the new government has signalled that it is ready to support growth with modest stimulus. Secondly, real progress has been made in the euro zone in recent months, and we expect this to continue in 2013. The reduction of these key fears will pave the way for 8-10% upside from the quoted property sector in 2013."
Asia: the cheapest region on a discount to Net Asset Value (NAV) basis
"2012 was a strong year for quality Chinese residential developers, with share prices up 50%-130% – albeit from a low base. The high-quality companies hit their full-year sales targets as early as September in 2012, and sales data remained strong into the year end. After such a rapid rise it would be prudent to exercise some caution, but even at today’s levels property share prices trade below their long-term average discounts to NAV. Even if you assume zero growth in China, which we do not, a reduction in the discount to NAV to the long-term average implies 10-20% upside over the next few years. Supply and demand dynamics are positive and we expect 10-15% upside in Chinese property stocks in 2013.
"The Hong Kong government has attempted to put the brakes on top-end residential property with the introduction of a special Stamp Duty. As a result, the property share price gains in Hong Kong have been more modest than in China over 2012, although we expect residential sales to recover in 2013. Our focus remains on commercial property, which is in short supply. The big risk for Hong Kong (and by extension, China) in 2013 is if US interest rates rise. If the Federal Reserve (Fed) increases interest rates it will have a direct impact on mortgage rates in Hong Kong. However, given that there would have to be robust evidence of economic growth in the US before the Fed would raise rates, such a move would clearly not be negative for the property sector overall. In any case, we do not expect the Fed to increase interest rates until late 2013 at the earliest.
"Japan’s property sector continues to benefit from a steady decline in supply and a shift away from earthquake prone buildings to A-quality properties. While the markets outside of Tokyo are stagnating from the weight of an overall sluggish economy, Tokyo is recovering and the Japanese development companies are leading the charge. With no major additions to supply on the horizon, rental rates should rise steadily throughout the coming year, regardless of the pace of domestic economic growth. Japanese companies are currently trading at 25% below NAV, which we believe is 10% over discounted.
"The dispersion in performance of property companies within their home markets in Asia has been especially wide and is not readily explainable by fundamental values or trends. This environment allows us to exploit value opportunities and highlights the importance of stock selection in the current turbulent environment."
Europe: Two steps forward, one step back
"The resolution of the euro zone crisis could stimulate rising property valuations, although we use the term ‘resolution’ quite loosely. Investor confidence is slowly improving with the expectation that the governments of Europe are working together to avoid a more serious crisis, which could result in an economic recovery later in 2013. We are optimistic that a severe crisis has been avoided, but the path to recovery will be bumpy. We expect the ‘two steps forward, one step back’ condition to predominate.
"The Continent’s largest company, Unibail, raised 6-year convertible debt capital with a coupon of 0.75%, and other companies are following suit. These public property companies have ample access to debt and equity capital and are improving their capital structures so that they are well prepared to purchase any properties, or companies, that look attractive. Rising property values, despite lacklustre return expectations, have pushed discounts to NAV for the property companies to 10-15% from 25% earlier in the year. Note that these valuations assume no rental growth or development value for the next two years, and are clearly conservative given the lack of current and future supply. We expect a 10% return from European property companies in 2013 – almost half of which will come from dividends."
UK: Foreign capital floods London’s West End
"The London property market continues to perform well as investors from around the globe seek to take positions. London, unlike the rest of the UK, is booming due to an invasion of foreign capital rather than as a result of internal economic growth. The office market is benefiting from demand from technology, insurance and media tenants, which have more than adequately offset any decline in demand from the financial sector. We will continue to emphasise West End developer/redevelopers."
US: The housing market is bottoming
"The US has agreed a deal to avoid the fiscal cliff – heading off an immediate crisis – and further progress to turn the ‘cliff’ into a gentle slope is likely over the coming months. Reducing the uncertainty on taxes, health care and a plan for ultimately addressing, if not reducing, the huge government deficits should enhance both the US and global economic growth prospects. The ‘fiscal cliff’ is being used as an excuse for inaction but, once we have some certainty, many businesses will step-up capital expenditure and begin to take on more staff. Additionally, we are believers in the improving sentiment towards US single family housing and see this gradual improvement in sales, pricing, and eventually starts as a primary driver for US commercial real estate in coming quarters. We remain wary of the apartment sector as there is a slew of new supply set for completion within the next 12-24 months.
"The US’ ‘safe harbour’ status throughout the financial crisis means that US REITs trade at 5-10% premiums to NAV. US REIT dividend yields are currently between 3-4% and we expect earnings to grow by 8-9% in 2013."
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