The Case for Real Estate Securities

A cheaper way to hedge inflation.

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story_images_glassbuildingI attended a session on real estate securities held last week by BNP Paribas Investment Partners at their Toronto office. I was particularly interested in how they can be used as an inflation hedge. Below are some notes and a couple of slides from speaker Shaun Stevens, BNP Paribas’ senior investment specialist, global real estate.

I also asked him about the major disparity that’s evident between the U.S. and Canadian real estate markets (see Chart 2). In case you’re wondering, Shaun gave me the following explanation: “Based on the FTSE EPRA indices the US market has grown in real terms over the past 20 years whereas Canada experienced a sharp fall in listed property prices during the 1990s in particular. Another thing to bear in mind is that the Canadian investment universe is pretty small and thus its index more vulnerable to sharper swings.”

Hope you enjoy his other comments on real estate securities and inflation hedging below:

Property has experienced a spectacular rise, fall and subsequent recovery over the past 5 years. Despite the challenging period of turbulence, the characteristics that attracted investors to the asset class before the onset of the recent financial crisis still remain intact.

Why reinvest in real estate securities?

Listed property has established itself as a separate asset class offering investors the most liquid and transparent access to international property markets. Listed property has the ability to bring attractive long-term performance and diversification to a portfolio. It remains the most cost effective way for investors to diversify their existing property portfolios and gain access to markets in different parts of the world. Listed property can provide sustainable income derived from cash flows of the underlying property portfolios, which can be used by institutional investors to offset long-term demographic needs.

Real estate securities can also replicate the inflation hedging characteristics of owning direct property. Property companies can offset changes in the consumer price index through index-linked lease contracts. In many markets like the US, France and the Netherlands, real estate can act as an inflation hedge because changes in prices are factored into rent increases. For example in the US, retail and office leases typically include provisions that protect landlords from inflation during the term of a lease. Property companies can capture this increased income and pay it out to shareholders in the form of dividends.

In addition, when prices rise, investors in many countries typically look to move their money into property because they see it as a real asset and the land it occupies as a scarce and valued commodity. Property companies can benefit when investors behave this way in times of increasing inflation. REITs are property in a securitized form, and therefore when the demand for property increases, REIT share prices also increase.

Listed property has also provided returns that have exceeded inflation in many countries around the world. Our analysis of quarterly price and total returns in a number of global markets reveals that property returns were higher than inflation in the US, France, Hong Kong and Australia, while underperforming in markets like Canada and Japan.

Investors looking to restore property to their portfolios would be advised to consider the durability of listed real estate companies. The major real estate companies have survived the early part of the credit crisis, battered and bruised but nonetheless intact, even after a heavy mauling. It’s a well-kept secret that not one major listed real estate company has gone bust in the past three years, despite the beating that bricks and mortar companies have endured since the recent financial crisis began. The credit crisis hit commercial real estate companies as hard as any other property owner over the three years. Billions of dollars in asset values have been written off globally, and neither real estate investment trusts (REITs) nor property companies have escaped.

The main drivers behind the listed sector’s durability and subsequent recovery were the steps taken by management teams to restore their balance sheets. From early 2009 to the end of April 2010, listed property companies have raised around USD 80 billion in equity to tackle the threat to their viability, posed by the contraction of credit availability post-Lehman. Moreover, despite the many difficulties that property owners have faced in extending or renegotiating terms in the private markets, real estate companies have been successful in raising billions of dollars in debt over the same period.

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