Global Market Review
Global REITs continue to benefit from the 3 R’s: Re-opening, reflation and re-calibration. We expect these tailwinds to persist for the next few years.
The global REIT market continued to benefit from the re-opening, reflation and re-calibration themes in the second quarter. In the United States., REITs outperformed the broader equity markets by approximately 200 bps. In Europe, REITS outperformed general equity markets by over 300 bps in the quarter. Geographic regions that made the most progress in vaccination implementation outperformed those regions that were slower to roll them out. As a result, U.S. and European REITs outperformed Asian REITs in the quarter. The quarter, however, was not without volatility as investor concerns around the COVID-19 Delta variant, triggered by new states of emergency in parts of Asia Pacific and Europe, weighed on investor sentiment about the timing of the re-opening.
The 10-year Treasury yield in the United States increased from 0.91% to 1.74% in the first quarter but tempered slightly in the second quarter to settle in a range of approximately 1.30% to 1.65. Notably, in spite of the interest rate increase, REITs in the United States were up significantly and outperformed the broad market as the combination of re-opening opportunities in the space and property types with secular growth appealed to investors.
Active management continues to be important component of the investor toolbox as opportunities shift from earnings streams that benefitted or were resilient to the pandemic to those that were temporarily impacted, but where long-term demand trends are intact. In 2021, REIT investors will need to effectively balance reflation opportunities (shorter lease duration companies), with earnings and re-opening opportunities to maximize alpha generation. We expect continued M&A activity as improved fundamentals and increasing valuations narrow the bid/ask of buyers and sellers and $350 billion of capital targeted for commercial real estate sits on the sidelines. Two of our largest overweight positions were acquired during the quarter; QTS, a large data center REIT, was acquired by Blackstone at a 21% premium to its last traded value and New Senior Living, an independent living and assisted living landlord, was acquired by Ventas at a 20% plus premium to last traded value.
The best performers during the quarter were self storage and mall companies. Self-storage had a demand boost during the pandemic and is positioned well in a reflationary environment with monthly leases and low labor expenses. Malls continue to benefit from pent up consumer demand trends. The worst performing sectors during the quarter were lodging and healthcare. Lodging gave back some of its first quarter relative outperformance on concerns over the pace of the corporate travel recovery and concerns over employee wage inflation. We continue to expect a shift in earnings growth leaders in 2021 from companies that were least impacted by the pandemic to those most impacted, especially during second quarter 2021 year-over-year earnings comparisons.
Real estate trends that were in place prior to COVID-19 are accelerating. The penetration of e-commerce and grocery e-commerce, at the expense of bricks and mortar real estate, is accelerating as new adapters are forced to use e-commerce, and many will remain as long-term participants. Mandated work from home in most parts of the developed world will lead to less demand for office real estate globally as firms realize portions of their business can work remotely without a loss in productivity. We have seen announcements from governments, like in Japan, which provided incentives to employers to have their employees work from home and in Germany, where new legislation provides a legal right for some workers to work from home. While these trends may be a negative for retail and office space, they are a positive for last mile industrial, cold storage, and data centers.
Due to very limited real estate supply additions and rapidly accelerating global economic growth, we expect a stock pickers’ market with some very attractive investment opportunities deriving from a disciplined long-term real estate fundamentals-based approach.
We are balancing our opportunities between those companies whose fundamentals will benefit or be less impacted in the current environment with value opportunities in property types that have been most negatively impacted by the current environment. As a result, we are overweight global logistics and global affordable and mid-level priced housing, based on fundamentals and valuation. We are overweight hotel companies globally, particularly in Japan and the U.S. multifamily and senior housing companies. Geographically, we are overweight the United Kingdom based on relative valuation, although we recently found tactical opportunities in continental European office and retail companies. We are overweight Hong Kong developers based on valuation and an economic recovery as China eventually re-opens its borders with Hong Kong. We remain underweight retail and office globally as technology secularly disrupts those business models, however we have found some tactical opportunities in both office and retail as investors may be overly discounting work from home and retail tenant bankruptcies.