Barron’s Profile: PGIM Real Estate
In this article, Barron’s discusses how Rick Romano’s team has found opportunities for outperformance
The global REIT market benefitted from the re-opening and economic recovery theme of the first quarter. In the United States, REITs outperformed the broader equity markets by approximately 300 bps; however, in Europe where there is more concern about the vaccination roll out, general equity markets outperformed REITs. Global geographic regions that have made the most progress in the vaccination implementation outperformed those regions that were slower to roll out vaccinations. As a result, U.S. REITs outperformed
both Europe and Asia REITs. The quarter, however, was not without volatility as investor concerns around the run up in value stocks, combined with new lockdowns in Europe and the United States and new virus variants that may be more resistant to current vaccines, weighed on investor sentiment about the timing of the re-opening.
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The U.S. REIT market gained 9.1% in the first quarter of 2021, as a better than expected vaccination roll out helped drive upward revisions to economic growth and overall sentiment towards the asset class.
The REIT market’s relative strength occurred despite a near doubling of long-term rates with the 10-year yield moving from 0.91% to 1.74%. We believe that the sentiment headwind traditionally associated with rising rates has been eclipsed by the fundamental benefits to the sector resulting from the reopening of the economy. The U.S. REIT market has outperformed the broader S&P 500 by roughly 300 bps so far in 2021 but is only up 2.5% since the end of 2019 compared to a 29% gain for the S&P 500.
The U.S. REIT market as well positioned for 2021. Despite the recent recovery, valuation remains attractive at a 5.0% implied cap rate, or roughly 350 bps spread to the 10-year (vs. a long-term average of 320 bps). Despite some near-term disruption to NOI growth in certain sectors, we expect FFO per share growth of 4.5% in 2021, followed by an impressive 7.5% in 2022. The recent improvement in REIT equity valuations has allowed many REITs to get back on offense with new equity issuance going towards acquisitions and development. A favorable cost of capital and faster pace of reopening bode well for upside to our near-term earnings expectations.
Market volatility resulting from the pandemic has magnified return dispersion within the REIT market and greatly increased the advantage of active management. PGIM Real Estate maintains a barbell approach to its REIT allocation, looking to capitalize on both “reopening” sectors as well as the secular winners. Despite significant outperformance from COVID-19-induced trough pricing, there is still value in the lodging sector as fundamentals start to normalize over the next year. Attractive valuations and an improving occupancy outlooks has resulted in increased weighting to the multifamily and senior housing sectors.
In a choppy month for markets, the European real estate sector closed out March broadly where it began the year, as interest rates remained volatile and virus news ebbed and flowed.
European real estate posted a 3.6% total return (+0.7% USD) in March, underperforming both the broader Stoxx 600 index (-300 bps) and the EPRA global real estate index (-270 bps USD) for the third month in a row. Currency was a factor in Europe’s relative USD underperformance as the dollar rose 2.9% vs the euro and 3.5% vs the Swedish kroner. The British pound lost 1.1% against the greenback in March.
2021 is likely to be a tale of two halves as vaccine efforts ramp up through the summer, thus paving the way for a broader economic re-opening later this year, with the UK leading the continent. Current valuations reflect this divergence. UK real estate is trading around a -3% discount to NAV versus continental Europe which is on a -20% discount, although the range remains very wide across individual sub-sectors. In terms of implied cap rates, the UK is at 4.8%, a 400 bps spread to 10-year gilts, and continental stocks trade at 4.7%, a 500 bps spread to 10-year bunds. These spreads remain attractive versus long run averages of 330 and 450 bps for the UK and Europe, respectively.
Fourth quarter 2020 reporting reinforced the view that 2021 will be a transition year for earnings growth across much of the space, with logistics and alternatives excepted, but early signs of life in some leasing markets are encouraging, setting up 2022 for a return to growth. Meanwhile, logistics fundamentals continue to surprise to the upside despite the stocks’ recent underperformance. Retail remains plagued by structural challenges with limited signs yet as to where the sector will stabilize in the new normal.
The Asian real estate equity market rallied +6.14%5 during the first quarter of 2021 compared to a -27.5% decline a year ago when the market was severely weighed by the onset of the COVID-19 pandemic and the ensuing widespread risk-off sentiment.
The uplift was prompted by an increasing daily vaccination rate in the region, leading to optimism for stronger economic recovery and earlier than forecasted reopening of borders. For developers, Hong Kong led the pack (+10.1%6in USD terms), followed by Japan (+7.5%) and Singapore (+2.1%). For REITs, only Japan delivered a gain (+5.3%). Australian and Singapore REITs posted losses of -2.1% and -0.5% respectively.
PGIM Real Estate is optimistic for 2021, premised on an economic recovery aided by economic stimulus and the gradual easing of restrictive movements with successful vaccine development. The outbreak of COVID-19 has ushered in a period of unprecedented global monetary easing and fiscal stimulus as countries tried to cope with the economic fallout. As Asia virus caseloads dwindled in the past few months, the focus is now on the reopening and delivery of an effective vaccine. Sectors that have witnessed a significant contraction in demand (i.e. hospitality and retail) will likely see a strong recovery in the coming months. In the near-term, the following themes could be in focus: (1) COVID-19 and vaccine impact on society and economy, (2) economic stimulus response, (3) bond yield spike on inflation expectations, (4) recovery in retail and hospitality, and (5) U.S.-China relations.
For more details, read the full Market Review and Outlook, which is available for financial professionals.
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.
1048050-00001-00 Ed: 05/21