Reits prospects in US, Britain outshine outlook in Singapore

Two First State Investments executives tell Jeremy Koh about the firm's strategy and the outlook for Reits in our series featuring fund managers and leading market experts.

Mr Stephen Hayes and his team manage US$2.4 billion (S$3.3 billion) of property stocks, including Reits, through different funds. PHOTO: FIRST STATE INVESTMENTS
Portfolio manager Tim Shaw focuses on Asian markets and says there are better investment opportunities outside Singapore.

The real estate investment trust (Reit) market here offers decent returns, but prospects for the markets in Britain and the United States are more promising, according to First State's Mr Stephen Hayes and Mr Tim Shaw.

Mr Hayes, the head of global property securities, and his team manage US$2.4 billion (S$3.3 billion) of property stocks, including Reits, through different funds. Each fund's investments depend on its investment objectives and geographic focus.

The firm's Global Property Investments fund puts its cash mostly in Reits, but also in companies that derive "stable" cash flows from high-quality properties, said portfolio manager Mr Shaw.

Modest economic growth and job creation in the US and Britain have significantly improved prospects for Reits there, Mr Hayes told The Sunday Times.

"Because economic growth has been slow and grinding since the financial crisis, we haven't seen a major supply (increase in the US and Britain) yet. We're not expecting one generally.

"The landlord can be choosy about which tenant he has and what rents he demands once the lease comes up for negotiation or renewal."

Mr Shaw, who focuses on Asian markets, said the Global Property Investments fund saw better opportunities outside Singapore.

Office rents here fell by 7.1 per cent in the year to Sept 30. And lease renewals of retail units are yielding rental increases of only around 5 per cent. Leases here are typically renewed every three years.

Yet rents in some sectors in the US are soaring at about 15 per cent a year, while commercial rents in Tokyo grew 4.6 per cent in the 12 months to Sept 30.

Mr Hayes took charge of First State's Global Property Investments fund in 2012 and began restructuring the department.

This fund managed about $11.2 million of assets as at Aug 31. Then, it was 54.6 per cent invested in the US, 12 per cent in Britain and 8.6 per cent in Japan. The rest was in places such as Hong Kong, Canada, Germany and Australia.

It has outperformed the industry benchmark by 2.6 per cent over the past two years and 5.3 per cent over the last year. These figures include the management fee of 1.5 per cent but exclude the initial charge of 5 per cent.

The benchmark used from 2008 to January last year was the UBS Global Real Estate Investors Index before it began using the FTSE Epra/Nareit Developed Index.

Q What are the return characteristics of Reits?

A Incoming cash flows are very stable relatively as they are from contracted rental income streams. This is very different to investing in an equity.

The cash flows also provide a good inflationary hedge as typically through an economic cycle, they grow at the rate of inflation or faster than inflation.

The Reit market may move in a way that is highly correlated to the equity markets in the shorter term - like what we witnessed in August when we had a global sell-off in equity markets.

On the very long-term time horizon, however, Reits are quite lowly correlated to the equity markets.

Q What is your style of fund management?

A We try to understand (real estate market) demand and supply, rents, values, government policy and the macroeconomic environment. Then we look at the Reits and see what assets they own.

We put an intrinsic value around the Reits by financial modelling, and then focus on what we expect returns to be around 12 months.

Based on these we have a table which ranks every Reit. After we have identified the ones we want to invest in, we look at the resulting total sector and country allocation from a risk assessment basis to see if that's an appropriate allocation.

Q How is the Global Property Investments fund different from other Reit funds?

A Our portfolio will typically look nothing like benchmarks as we do not emulate benchmarks of the market. We can invest a lot of capital in smaller opportunities. For instance, there are about 325 stocks in our benchmark and we're invested in around 45.

Q What is the Global Property Investments fund invested in in the US?

A Our largest exposure is to the US. I've never seen major shopping malls, industrial warehouses, storage facilities, apartments so highly occupied there.

Our apartment exposures on the West Coast are in southern California, northern California, Oregon and Seattle, Washington.

We're seeing a huge amount of intellectual capital attracted to the West Coast. These people are very career-minded, they're very well-educated, extremely well-paid and getting married later. They're not wanting to own their own homes, they're opting to rent.

We've also got a high amount of exposure to hotels in the US. The buildings are very highly occupied. The average occupancy of a five-star hotel or full-service hotel in the US is over 80 per cent now.

Once you start to get occupancy around these sorts of levels or higher, hotels are able to push room rates quite hard and grow bottom-line earnings.

The US dollar has been strong, which means there are headwinds to net exports but the buildings are so highly occupied and that's very attractive to us.

We're also invested in office buildings in major cities like San Francisco, Boston and mid-town Manhattan.

Q What is the Global Property Investments fund invested in Britain?

A We are predominantly invested in office, and the West End (in London) is where our largest concentrations are. We also own some CBD office buildings and high quality shopping malls.

Real wage growth in the United Kingdom is now over 3.5 per cent. If you combine wage growth with the fact that more people are working, you know household income growth is very strong. That should benefit retail and eventually lead to market rental growth for dominant shopping centres.

Occupancy rates for the West End of London are now at about 97 per cent. It's very difficult to build there as there are major height restrictions. The tenant demand is very strong and it's very broad - across finance and insurance, and many other services. That's very encouraging for us.

Q What is your take on the Singapore market?

A The Global Property Investments fund currently has no exposure here. We were concerned that office space coming to the market in 2016 would affect rents.

Singapore Reit prices have become more competitive in the past quarter. However, we are still seeing stronger fundamentals in the US, European and Japanese markets.

The prices in condominiums have been relatively lacklustre after the cooling measures that were put in place from 2010 onwards.

For the retail sector, in the last five years we've seen increasing supply and issues attracting staff. The economy has also slowed a bit in the last 12 months.

Retail sales are relatively robust, but rental reversions - the amount a landlord can raise rents by when a lease is renewed - have come down from about 8 per cent to 5 per cent. Leases are typically renewed every three years. It's not a concerning issue, but it's a slowing of what was a relatively positive story .

Comparatively, in the US, there are sectors where rents are growing 15 per cent year on year. In Tokyo, commercial rents grew 4.6 per cent in the year to Sept 30.

Q What will be the impact of an interest rate increase on Reits?

A When the US Federal Reserve or Bank of England raises rates, the immediate and short-term effect is that short-term interest rates will go up. There might be a bit of volatility but this shouldn't really impact the Reit sector as the underlying real estate assets are long-term assets. Their prices tend to be affected by long-term interest rates.

Longer-term interest rates will only likely increase when we start seeing stronger wage growth and inflation. As that happens, real estate pricing might come down a bit.

The counter to that is the longer-term rates are moving out because of inflationary expectations and real estate is a very good inflationary hedge. So you would think real estate cash flows would be going up similarly or, if not, with a bit of a lag.

We are not looking for a dramatic sell-off in real estate markets should rates rise.

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A version of this article appeared in the print edition of The Sunday Times on October 18, 2015, with the headline Reits prospects in US, Britain outshine outlook in Singapore. Subscribe