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Jon Cheigh, head of global real estate, Cohen & Steers.
As we know, 2018 was a very challenging year. In particular, 4th quarter of 2018 was a very challenging year. Global stocks were down 13.4%, and this was a story that existed across all developed markets, with all developed markets also down double digits.
But, underneath the surface, there have been some positive stories. What we found within the global real estate universe was only down 5.7%, outperforming global equities by more than 700 basis points.
This is not just a story that’s global in the aggregate. We saw this in the U.S., we saw this in Europe, we saw it in Asia-Pacific, we saw it in emerging markets. In each and every region, real estate stocks outperformed the overall equity market. As an example, Asia-Pacific, in U.S. dollar terms, the equity market was down 11%, while the real estate market was only down 0.9%.
So, what was driving this very dramatic outperformance of real estate across the globe? In our view, it’s several very important, and we think durable, attributes.
Firstly, real estate companies tend to pay a very tangible and above average dividend yield. Secondly, the earning streams of these companies tend to be much more durable and less volatile than the average company.
Why is that? The underlying cashflows of these companies are driven by the office buildings, the apartment buildings, the warehouses or the shopping centers that these companies own, and they derive their income through contractual leases. These leases can be three years, five years, 10 years, or 15 years, depending upon the market or the property type.
While the economy globally might go up or down in a given year, slow or accelerate, these real estate companies continue to generate and receive this contractual income. So, this is why you would expect that a real estate company that generates cashflow from these kinds of sustainable and durable cashflows and leases should be much more defensive than if you were to invest in a auto company, an airline, or someone that was manufacturing and selling iPhones or something like that.
So, the other example that we need to think about when looking at the cashflows of these companies, it’s not just these cashflows and the contractual income from these leases. You also don’t need to focus on some of the issues that are in the news more recently. Tariffs. Supply chains. Trade war. Real estate companies, they tend not to be multi-nationals, they tend not to have supply chains. These are companies that own shopping centers, they own apartment buildings, and they own office buildings. What drives them is their local economy.
So you see, there are a number of different attributes that have driven the outperformance of real estate in the 4th quarter. The other thing to think about, is that it hasn’t just been a 4th quarter effect. This outperformance actually began earlier in the year, before much of this turbulence had begun. In our view, the early part of that outperformance, which has continued, some of it were the attributes I talked about, but some of it was that real estate companies had underperformed the global equity market for the last three to five years.
Now, that might seem surprising to some, but what happened was that the rest of the equity markets had tended to have their earnings, multiples, see expansion, meaning their P/E multiples, had expanded, and some of the very strong returns in the equity market the last few years has not been from earnings growth, it’s from multiple expansion.
In contrast, you have not seen or had not seen that phenomenon in the real estate companies. You’d seen steady and healthy earnings growth, but earnings multiples had been very stable over the last five or six years. In some cases, they had contracted.
And so, in our view, real estate companies have begun to outperform the market for some of these attributes, like yield, durability, simplicity, but just as importantly, they were attractively valued. They had seen no multiple expansion, and in a market where perhaps some were concerned about slowing growth, some were concerned about high valuations of things that had gone up a lot over the last few years, or lots of concerns about trade wars and things like that, this was an industry that did not have those problems. So, to us, it’s quite unsurprising that we’ve seen this rotation of capital in to what we think are good fundamentals and a good valuation.