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Positive vaccine news and clarity on the U.S. Presidential election results drove performance in global REITs for the fourth quarter. Pfizer released news of their COVID-19 phase 3 clinical trials and surprised investors with a highly effective 90% efficacy rate. Moderna announced similar vaccine results shortly thereafter. Additionally, the hotly contested U.S. Presidential election ultimately produced a clear winner after several days of ballot counting.
Global REITs were up over 13% during the quarter. A clear economic re-opening signal was a significant catalyst for REIT outperformance since the pandemic hit right at the heart of real estate and impacted how people live, work, and play. Investor concerns remain regarding the magnitude of the “COVID Winter” virus outbreak and new mutations that may spread more easily and/or be more resilient to existing vaccines; however, continued government stimulus and vaccine roll outs have investors optimistic that COVID winter impacts will be temporary. Active management continues to be an important tool in the investor toolbox as opportunities shift from earnings streams that benefitted or were resilient to the pandemic to earnings streams that were temporarily impacted by the pandemic, but long-term demand trends are intact.
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The U.S. REIT market rallied 12.7% during the fourth quarter of 2020, modestly outperforming the S&P 500, which produced a total return of 12.1%. Clarity on the U.S. Presidential election combined with better-than-expected vaccine efficacy announcements from Pfizer and Moderna drove a substantial risk-on rally in equities. Despite the near 50% rally in REITs off the COVID-19 induced lows in late March, the group still sits roughly 20% below pre-pandemic levels.
Several sectors in the U.S., such as office and retail, face secular challenges of work-from-home and ecommerce adoption that are likely to prolong the recovery and may result in a permanently lower demand curve. The silver lining of the pandemic has been the dramatic drop of construction activity across all property-types, which should help further propel the recovery as demand improves.
The best performing sectors during the fourth quarter were lodging and retail. Lodging REITs were up over 50% for the quarter. Positive vaccine news increased investor confidence in the pace of the RevPAR recovery in 2021. Despite this recent move, we remain overweight lodging and see more upside as the recovery truly begins. Shopping center REITs and malls jumped 30-35% during the quarter, largely reflecting performance reversion as one of the worst performing sectors this year. We remain cautious on retail longer term as demand trends are unlikely to improve, and the risk of future tenant bankruptcy and store closures remains high.
The worst performing sectors for the fourth quarter were data centers and industrial REITs, with data centers posting a modest decline in share price. As investors seek to capitalize on the reopening trade, these more defensive sectors have been used as funding sources.
The European public real estate market continued its recovery from March. The European public real estate market finished the year strongly with a 6.2% (USD gross total return) for the month of December as markets grew more optimistic on an imminent recovery in 2021 with further COVID vaccine approvals. Europe’s strong performance in December again made it the best performing region for the month and capped off a remarkable market rebound in the fourth quarter totaling 16.9%. The robust 4Q return cemented Europe’s position as the best performing region over the entire year 2020.
Switzerland was the best performer for the month with a 9.2% total return followed by Germany with 7.3%. Both countries benefitted from the catch-up in defensive stocks in December after the huge jumps in more cyclical and deep value stocks in November. Germany finished the year as the top performer over the full year with a total return of 31.0% as its resilient residential sector stood out throughout a year of economic crisis as national economies shut down.
France had a second consecutive strong month with a 6.6% total return, but it was not enough to move it up from last place in Europe for the full year period with a total return of -32.8%. The UK was in-line with the European average in December with a return of 6.3%, but it finished the year with a lagging total return of -13.6% despite the modest 3.1% gain of the GBP against the USD.
The European public real estate index has recovered approximately 35% since hitting its mid-March 2020 trough, with the last major step up in November on news of two successful vaccines trials. Following the significant rally from trough valuations reached in March 2020, the European region now trades on an average 9% discount to forecast 2021 NAVs and a 3.8% average dividend yield. However, there is a very wide dispersion of NAV discounts, ranging from an average double-digit premium in the industrial/logistics sector to discounts of up to 50% in retail. Europe trades on an average implied cap rate of 4.5%, a premium of approximately 500 basis points to the current negative German 10-year government bond yield.
As countries emerge from the crisis, the inherent attraction of long income streams from real asset rents in a depressed interest rate environment again move to the forefront of investor attention. Private capital is also still waiting on the sidelines for any signs of distressed assets or companies that could be taken private. However, it is clear that all economies and the real estate market will be permanently altered to varying degrees by this dramatic crisis.
The Asian real estate equity market declined 12.6%1 in 2020, erasing the gains achieved in 2019. The real estate sector (both developers and REITs) across the region underperformed the broader markets, with Singapore being the only exception. Amongst the developers, Hong Kong fell the most (-19.7% in USD terms), followed by Japan (-10.8%) and Singapore (-9.7%). For REITs, Australia rose 0.8% in 2020, while Singapore (-6.1%) and Japan (-12.3%) contracted.
While prompt government stimulus packages managed to contain the full-blown negative impact of the COVID-19 pandemic, hospitality retail and office landlords bore part of the costs associated with the fallout through rental assistance. The absence of clarity with regard to the duration of the pandemic led to the REITs suspending forward earnings guidance. Dividend payout was no longer a certainty. For office, calls for work-from-home by the authorities around the region begged the question of future demand for office spaces and the implications on rental growths going forward. On the other hand, logistics and data centers were deemed attractive, benefitting from strong demand growth as ecommerce penetration accelerated on the back of imposed lockdowns.
Markets remain vulnerable, with global re-opening fraught with the risk of subsequent wave impacts amid growing economic and social marginalization. The effectiveness of vaccine delivery would be closely monitored as an indicator of reopening momentum. A new U.S. President would also help stabilize geopolitical and trade relations with the region. Within our individual sectors, a sharper rise in sovereign bond yields could negatively impact regional REIT valuations. In the event of a long-drawn fight against the COVID-19 virus or a delay in the production of an effective vaccine, economic growth would remain in check until the latter half of the year.
1 FTSE EPRA/NAREIT Developed Asia in USD Index. As of 31-Dec-2020.
Past performance is no guarantee of future results. The views expressed herein are those of PGIM Real Estate investment professionals at the time the comments were made and may not be reflective of their current opinions and are subject to change without notice. Neither the information contained herein nor any opinion expressed shall be construed to constitute investment advice or an offer to sell or a solicitation to buy any securities mentioned herein. This commentary does not purport to provide any legal, tax, or accounting advice. Certain information in this commentary has been obtained from sources believed to be reliable as of the date presented; however, we cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. The information contained herein is current as of the date of issuance (or such earlier date as referenced herein) and is subject to change without notice.
Investing in real estate poses certain risks related to overall and specific economic conditions, as well as risks related to individual property, credit, and interest rate fluctuations. Real estate investment trusts (REITs) may not be suitable for all investors. There is no guarantee a REIT will pay distributions given the inherent risks associated with the market. A REIT may fail to qualify as a REIT as defined in the Tax Code, which could affect operations and negatively impact the ability to make distributions. There is no guarantee a REIT’s investment objectives will be achieved.
1038636-00003-00 Ed. 02/2021