An interest rate rise should not stop the real estate sector from growing says Schroder Global Real Estate
After a strong year for listed real estate securities, many investors could be wondering whether the sector can continue to grow in an economic environment which may see rising interest rates. Below Tom Walker and Hugo Machin, managers of the Schroder Global Property Securities Fund which has generated 190bps of outperformance net of fees for the 12 months to the end of Oct 20151, share their views on why they think the sector can continue to grow.
In 2014 the listed real estate sector delivered returns of over 15%, with the US alone rising by over 30%. We believe that the continuation of a low growth environment will be supportive of the real estate sector as long as investors are selective in their approach. With bond yields at historically low levels and investors searching for income, real estate offers both income and the potential for capital growth.
There is a belief that an interest rate rise could cause the listed real estate sector to underperform. We believe that this is misguided. Looking back over 2004-2006, which saw a total of 17 US Fed rate increases against the background of an improving economic climate, it can be seen that the US listed real estate market still delivered returns of almost 80%. Moreover, compared with yields against government bonds, listed real estate yields look strong. Even in markets such as the US West Coast and London, bond yields will have to rise by a notable margin to be a threat. Rates are a tool used to curb inflation. Rate rises signify to real estate investors that economic growth is strong, leading to stronger rents for real estate assets. In the current context, 25 basis point rise signifies a growing economy coupled with a rise of little significance that won’t increase lending costs. Indeed, growth in rents should more than offset lending costs.
Growing demand in major cities, which is expected with increasing business sentiment, is good news for the listed market which tends to own the best assets in prime areas. As long as there is sustained rental growth, then any modest increases in interest rates are unlikely to have any significant effect on the attraction of these assets for investors.
The biggest risk to the property sector is oversupply, particularly as economies recover and developers push ahead with construction. However, in many locations new construction is being undertaken only on the back of space that has already been let. The low level of supply means that those companies owning property in the more desirable locations are seeing, not just capital appreciation, but rental growth too. In addition, the curb in bank lending to real estate has been seismic. Legislation makes it very costly for banks to lend to developers. This has given listed real estate companies, with access to the bond market, a competitive edge in developing or refurbishing assets.
1Morningstar as of 31 October 2015
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