The potential for growth in the U.S. real estate sector won’t dissipate over the next few years.
So says Chip McKinley, senior vice-president and portfolio manager with Cohen & Steers in New York. He manages the Renaissance Global Real Estate Fund.
“U.S. REITs have enjoyed strong returns over the last 12 to 14 months, [but] they’re still not that expensive,” he adds. In fact, “people forget that 2013 was actually a bad year for returns. That’s when Bernanke started to do his tapering [and] that caused a lot of negativity around liquidity, interest rates, and forward growth.”
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Over the past year, the sector entered the early innings of a longer-term bull market due to the strength of real cash flow growth, says McKinley. “And now, REITs are a little bit more expensive than the global average, but not by very much.”
He notes that U.S. REITs trade, on average, at a 13% premium to their underlying spot value. “That spot value, which we also call net asset value, is simply the value of the properties if you are trying to sell them today. That premium sounds like a lot, [given] the long-term average is about 5% to 7%.”
However, says McKinley, “you also have cash flow growth that is well above long-term averages. I would say in the context of growth, the current premiums are quite reasonable.” Over the next two to four years, he predicts long-term internal rates of return will still be very attractive.
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Around the globe
Global real estate markets are even more attractive than the U.S. market, says McKinley. He’s looking at the U.K., Germany, Hong Kong and, to a lesser extent, Japan.
“These are all countries that have listed real estate markets that are at some point of a development or growth cycle, and [their] valuations are materially cheaper than the U.S. All else equal, we’re favouring those countries as the best candidates for growth and total return on a risk-adjusted basis.”
Currently, McKinley is overweight globally and underweight the U.S. real estate market. But, he says, “that’s not because the U.S. is so expensive. We simply find some more attractive options in these four other countries.”