What does market volatility mean for investing in global property securities?
Although the global economy is suffering from a bout of lower growth and potential deflation, we think that the investment case for real estate is intact.
01 Sep 2015
Unstructured Learning Time
Market volatility is like a nasty case of the flu – not to be underestimated but ultimately not terminal.
The recent events in China and the wider ramifications for economic growth have, rightly, received huge attention. Precipitous moves in share prices have triggered dramatic headlines. Whilst market volatility signals a change in market sentiment, we remain of the view that high quality real estate is an important diversifier in a portfolio.
Our obsession with the prototype real estate business is a healthy one. Companies in markets with structural growth characteristics (defensive cash flows), low levels of debt and aligned management teams underpin our process.
The key is to look through share price swings to what underlying businesses are worth and take advantage of any opportunities that arise.
Long-term focus amidst market volatility
Pronounced moves in share prices are always uncomfortable for investors and often results in irrational decision making.
We remain focused on the analysis of the companies in our universe, thereby staying within our area of expertise. Businesses that hold irreplaceable assets in some of the most dynamic markets in the world will, in our view, provide investors with strong long-term returns. This strongly held approach is best summarised in the chart below:
What does this mean for investors in global real estate?
It is worth taking stock:
- Supply levels still remain low, due to a lack of development finance
- Cost of debt remains low; many companies are locked into highly favourable lending terms on long duration
- Gearing levels remain low with the key metric of interest coverage ratio at very high levels
- Oil price declines are a net positive
Whilst re-affirming these positives, the global economy is suffering from a bout of lower growth and potential deflation. The enormous debt burden remains the elephant in the room.
Real estate will remain an attractive asset class because of the defensive nature of the cashflows. Our bear case is that rental growth will slow as aggregate demand seeps out of the economy. The counter-balance remains a lower oil price, a key cost input, which will continue to act as a positive for the consumer.
Whilst lower growth is not ideal, we still think that the investment case for real estate is intact.
Emphasis on quality
Our investment philosophy means we take positions in companies at the higher end of the quality spectrum.
Strong and growing cashflows underpin real estate values. Unique locations and asset types feed into our view that non-commoditised real estate – at the right price – provides the best long-term returns.
We view commoditised real estate as a value trap. Companies with high and unsustainable yields in markets that are susceptible to new supply will, ultimately, struggle to perform. When leasing markets weaken, these assets suffer anaemic returns at best. These types of assets might perform at certain points in an economic cycle but, long-term, they have insufficient pricing power. We avoid companies that own commoditised real estate.
Trying to predict what might happen in financial markets is neither wise nor easy. As share prices oscillate, investors tend to feel uneasy about the future which further compounds share price moves.
We stick to our knitting by analysing companies that conform to our view of best-in-class. We look through large share price moves but acknowledge that market shocks can be a good time to exit (on the upside) or buy in (on the downside).
We think that a long-term exposure to a portfolio of globally diversified, liquid real estate with irreplaceable assets remains an attractive proposition