Timbercreek Global Real Estate Fund Quarterly Manager Commentary
As at September 29, 2017
By Corrado Russo, Senior Managing Director, Investments & Global Head of Securities Q3 2017 HIGHLIGHTS
• • •
Added one new direct real estate investment Exited Finland Increased exposure to France, New Zealand and the United States.
MARKET OVERVIEW Most global real estate securities markets quietly grinded higher during the third quarter driven by solid earnings and a global economy that continues to improve and incrementally surprise to the upside after years of muddling along. In Canadian dollar terms, global real estate securities ended the third quarter in negative territory, as the appreciation of the Canadian dollar driven by the Bank of Canada’s surprise decision to raise rates more than offset market gains in local currencies. All 45 countries tracked by the Organization for Economic Cooperation and Development (OECD) are expected to grow in 2017 and 2018, a synchronicity that has been uncommon over the past five decades. Improvements in economic conditions has given central banks greater confidence to raise rates (like in the U.S. and Canada), telegraph a rate increase (like the Bank of England) and consider tapering asset purchase programs (like in Continental Europe) designed to support capital markets and local economies in times of distress. Although political rhetoric continues to dominate the 24/7 news cycle, markets have instead focused its efforts on improvements in business and consumer confidence, manufacturing, and unemployment all of which positively influenced demand for commercial real estate space during the third quarter. Hong Kong led the way generating a +7.2% total return1 (HKD). Hong Kong property companies benefited from a bounce in retail sales (+4.4% in July) and continued strength in the city’s housing market with home prices up 10% YTD. Singapore outperformed generating a +3.2% total return2 (SGD), driven by a recovery in Grade A Central Business District (CBD) office rents, rising home sales fueled by new project launches and BlackRock’s sale of Asia Square Tower 2 for $2.1 billion (SGD) at a sub-3% cap rate. Continental Europe slightly outperformed during the quarter up 1.9%3 (EUR) led by Sweden (+5.5% SEK) and Germany (+4.4% EUR), while the Netherlands (-3.6% EUR) and Switzerland (-0.9% CHF) lagged. REITs on the Continent benefited from stronger economic growth and better business activity. Australia performed similar to the global market generating a +1.6% total return4 (AUD). Australia’s office and housing markets, particularly in Sydney and Melbourne, were a source of strength while retail fundamentals remained mixed. U.S. REITs although positive, underperformed generating a +0.7% total return5 (USD) as rising supply in senior housing, self-storage and select multi-family, office and lodging markets created headwinds during the quarter. Canadian REITs also managed to eke out a +0.1% total return6 (CAD) while the U.K.7 was flat with both countries trailing peers. We believe the U.K. suffers from a lack of confidence while Canadian REITs lagged due to Bank of Canada’s surprise decision to raise interest rates. Canadian REITs tend to underperform immediately after the initial rate hike and then outperform over the subsequent 12 months driven by a stronger economy. Japan was the only market in the world to generate a negative total return, down 3.3%8 (Yen). We believe Japan’s negative return was driven more by fund flows than anything else. That said, economic conditions in Japan are starting to show a sprinkling of optimism led by improving small and medium business confidence, accelerating produce prices and rising office rents in regional cities like Fukuoka, Sendai, Kyoto and Osaka. FUND PERFORMANCE The Fund generated a -0.4% total return on a net basis during the third quarter and is up 2.8% year-to-date. Performance was led by stock selection in Canada, the U.S. and Japan, as well as the Fund’s underweight to Japan and overweight to Singapore. In Canada, the OneREIT and Cominar REITs outperformed, generating +15.9% and +9.3% total return (CAD) respectively. In August, OneREIT announced the sale of the company to Smart REIT and Strathallen Acquisitions Inc. at a 14.5% premium to its previous day's closing price, causing the shares to outperform. Cominar REIT benefited from management’s new strategic plan which called for selling $1.2 billion of non-core assets in Ontario (except Ottawa), Alberta and Atlantic Canada, reducing debt, buying back stock and acquiring properties with better internal growth prospects. Investors applauded management’s more pro-active approach sending Cominar’s share price higher. In the U.S., both Kite Realty Trust and Store Capital Corp. outperformed generating a +8.6% and +12.2% total return (USD). Performance was driven by a better than expected second quarter earnings report demonstrating strong operating metrics despite the difficult retail environment. Leasing activity in Kite’s portfolio was strong with small shop occupancy up 90 bps and cash rent spreads on new and renewal leases up 9.8%. Store Capital reported better than expected acquisition guidance at lower leverage targets. In Japan, Invesco Office J-REIT outperformed generating a +1.9% total return (Yen). Invesco Office benefited from improving office fundamentals in regional cities, led by little new supply for mid-priced office buildings that cater to small and mid-sized tenants and a management team that has taken a western-style approach to capital allocation decisions such as initiating share buybacks. The portfolio’s underweight to Japan also positively contributed to performance as Japan trailed its global peers. The portfolio's overweight to Singapore positively contributed to performance driven by continued appetite for yield amongst global real estate investors. Annualized Returns9
YTD
1 Year
3 Year
5 Year
Since Inception10
Net Fund Returns
2.8%
0.6%
6.5%
7.6%
9.2%
The representative market indices are 1FTSE EPRA NAREIT Hong Kong Index. 2FTSE EPRA NAREIT Singapore Index. 3FTSE EPRA NAREIT Developed Europe ex UK Index. 4FTSE EPRA NAREIT Australia Index. 5EPRA NAREIT United States Total Return Index. 6FTSE EPRA NAREIT Canada Index. 7FTSE EPRA NAREIT U.K. Index. 8FTSE EPRA NAREIT Japan Index. 9The returns of the Fund are based on the returns of its Class A units and net of all fees and expenses . 10September 1, 2010. All currency in Canadian dollars unless stated otherwise.
Timbercreek Global Real Estate Fund Quarterly Manager Commentary
As at September 29, 2017
FUND PERFORMANCE CONT. REITs in Singapore provide some of the highest yields in the listed real estate universe and we believe REIT share prices have benefited from attractive valuations relative to global peers and improving economic data. More recently, a recovery in Grade A CBD office rents, rising home sales fueled by new project launches and BlackRock’s sale of Asia Square Tower 2 for $2.1 billion (SGD) at a sub-3% cap rate, have positively influenced share prices.
Portfolio Allocation By Sector
% of NAV
Portfolio Allocation By Region
% of NAV
Shopping Centre
29.0
United States
68.6
Office
16.8
Canada
12.4
Regional Mall
14.8
Singapore
9.9
Mortgage REITs
12.7
Netherlands
8.1
Stock selection in Hong Kong detracted the most from performance Hotel 11.9 Hong Kong 6.5 driven by Fortune REIT who’s share price underperformed its retail Diversified 9.9 peers (-2.7% HKD) as a result of the company delaying its asset Australia 6.4 enhancement plans at Fortune Kingswood. The project is expected to Industrial 8.2 France 3.7 be an important driver of future growth and led to Fortune’s share price Multi-family 7.6 reacting negatively to the news. We believe the delay is temporary and Japan 2.6 Triple Net Lease 6.0 should start in the coming quarters. Stock selection in Singapore Belgium 2.4 detracted from performance led by AIMS AMP Capital Industrial. AIMS Healthcare 4.3 delivered a sub-par second quarter earnings report. Industrial New Zealand 1.8 1.6 fundamentals in Singapore are soft due to new supply; however, we feel Single Family Rental United Kingdom 1.4 we are getting paid to wait for conditions to improve with the REIT Residential 1.4 paying a +7.5% dividend yield. Wereldhave in the Netherlands Ireland 0.5 Student Housing 0.1 underperformed generating a -2.1% total return (EUR). Wereldhave’s shares lagged due to weaker than expected operating results, driven primarily by France. Wereldhave recently hosted an investor day outlining steps they plan to take to improve operating performance. Efforts include bringing on a new head of their French division, introducing new concepts into their centres to increase traffic and sales and looking to add mixed-use components to their properties to create a better live-work-play environment. This is a trend we are seeing in other parts of the world as well. In the meantime, we feel we are getting paid to wait for operating metrics to improve with the stock generating a 7.8% dividend yield. The Fund’s U.S. REIT preferred holdings generated a small negative total return during the third quarter, down 0.8% (CAD) driven by the appreciation in the Canadian dollar which more than offset market gains in local currencies. Year-to-date, the Fund’s U.S. REIT preferred holdings are up 3.4% (CAD). Performance during the quarter was led by American Homes for Rent (AMH) Series E and Sunstone Hotel Investors Series E while Pennsylvania REIT Series C underperformed. AMH Series E outperformed driven by strong operating conditions and a favorable supply backdrop while Sunstone Series E benefited from better than expected economic growth, leisure travel, corporate profits and a weaker USD. Pennsylvania REIT Series C lagged due to negative retail sentiment. CHANGES IN PORTFOLIO Geographically, the portfolio’s exposure to France, New Zealand and the U.S. increased while exposure to Canada and Finland decreased. From a sector perspective, we added exposure to diversified REITs while decreasing exposure to shopping centres. From an asset class perspective, we added exposure to common equities and direct real estate investments in lieu of preferred shares and cash. During the quarter, we added one new common equity position in Canada (Automotive Properties Trust) and New Zealand (Kiwi Property Group) and established one new direct real estate debt investment in Ireland. On the sales side we exited three holdings, one each in Canada, Finland and Singapore. In Canada, we added Automotive Properties Trust (APR) to the portfolio. APR owns auto-dealerships in Canada located in its major markets – Toronto, Calgary, Vancouver, Montreal and Regina. The REIT was formed in 2015 when the Dalawri Group—who is the largest owner of dealerships in Canada—spun out some of its real estate. APR's portfolio is well diversified by brand; Honda at 17% of NOI, Audi, Porsche and Acura at 11% each, Nissan at 8% and BMW at 7% and market segment; mass market (57%), luxury (29%) and ultra-luxury (14%). Although 90% of APR's NOI comes from Dalawri-owned dealerships, EBITDAR coverage is very strong at 3.4x. Further, APR has minimal lease roll-over in the coming years with only one expiration occurring before 2026. APR's weighted average lease term is over 13 years with 1.5% embedded rent bumps per year. We believe the company's shares are attractively priced at over a 20% annualized return driven by a 7.4% dividend yield that is fully covered by existing cash flow. The company's high cap rate (>6.5%), low financing costs (~3.25%), low G&A (8% of NOI) and minimal maintenance CAPEX (~2% of NOI) all contribute to the REIT's attractive return profile. In New Zealand, we added Kiwi Property Group to the portfolio. Kiwi owns a high quality institutional portfolio of office (~70%) and retail centres (~30%) primarily located in Auckland (~60%) and Wellington (~15%). We established a position in the company mid-August after months of share price underperformance following their mid-June $161 million (NZD) equity raise. We believe the equity raise was the right thing to do as it provided additional funding for the company's Sylvia Park development while maintaining prudent leverage levels. Post-equity raise, Kiwi's balance sheet leverage declined over 5% to approximately 29%. Occupancy across the portfolio remains strong at over 98% with same-store growth of over 2.5%. The company's bricks and mortar retail centres are performing well with over 2% sales growth leading to lower occupancy costs for retailers. With roughly 26% of retail leases up for renewal annually, we believe the company should be able to capture attractive mark-to-market upside embedded in current leases. We believe valuation is attractive with the company trading at a 13% discount to NAV and a 9.1% annualized expected return. Within the direct real estate component of the portfolio, the Fund invested in a new loan secured by an office building in Dublin, Ireland. The building encompasses over 75K square feet of commercial space comprising office (73%), retail (16%) and restaurant space (11%). Transportation to the property is strong with a Luas stop immediately adjacent. The building is 92% leased. The duration of the loan is 48 months and is expected to generate mid double-digit returns.
Timbercreek Global Real Estate Fund Quarterly Manager Commentary
As at September 29, 2017
MARKET OUTLOOK As we enter the final three months of 2017, our global outlook hasn't changed from last quarter. The global economy continues to improve and incrementally surprise to the upside after years of muddling along. Consumer sentiment in the U.S. is strong and improving in Europe, corporate profits are rising, monetary policy is not a headwind (as of yet), unemployment continues to decline, China is faring well and even Japan is showing a sprinkling of optimism. We are mindful of where we are in the cycle and that markets continue to quietly grind higher, however, we are finding attractive investment opportunities. We believe REITs are poised to grow earnings at a significantly faster pace than the broader economy. While growth is not great on an absolute basis, demand and supply conditions are supportive of real estate fundamentals and we continue to see positive upside in rents as leases expire at below current market rents. This expected rental growth coupled with value-enhancing projects currently under construction by the companies within our portfolio should lead to growth in NAV. We expect that this growth in NAV, coupled with a stable but growing income stream, makes REITs an attractive place to invest in today’s market place. In the U.S., valuations have diverged between industrial and bricks and mortar retail. Demand for industrial space is strong led by ecommerce companies, and Amazon specifically, yet we find public market valuations a lot less attractive today compared to three months ago. Contrarily, a challenging leasing environment for bricks and mortar retail centres feels more than priced into the stocks. We are finding better value in shopping centres than malls. Technology-driven real estate sectors, such as data centres, are enjoying a strong demand backdrop but unlike industrial REITs, valuations point to further upside. We are positive on the residential sector but more specifically single family rental homes and west coast and southeast multi-family markets. We believe CBD office REITs screen attractive as a softening in net effective rents has caused the stocks to trade at large discounts to NAV. Supply headwinds in selfstorage and senior housing give us pause while we are becoming incrementally more positive on hotel REITs due to better economic conditions. In Canada, office fundamentals remain strong in downtown Toronto driven by creative office space that is drawing interest from technology, media and advertising companies. Availability rates are low and although numerous new projects are being developed, most of that space is spoken for. Calgary's office market remains extremely challenging with little-to-no demand, resulting in landlords having no pricing power. Net effective rents have dropped considerably (>30%). Calgary's multi-family market also remains challenging with Edmonton performing slightly better. Multi-family occupancy rates have outperformed the office sector on a relative basis. With oil inching upwards (now back to ~$50 per barrel), the hope out West is that fundamentals will soon bottom out, but we think it will take several more quarters. Unlike Calgary and Edmonton, multi-family fundamentals in Eastern Canada are good and we believe Toronto will continue to outperform its Quebec neighbors. Retail remains steady with tenant bankruptcies less disruptive in Canada than the U.S. The Bank of Canada raised rates during the third quarter for the first time since 2010. We believe the Bank of Canada raised rates due to better economic growth. Typically, better growth has a positive impact on real estate fundamentals. As economic conditions improve and companies expand, demand for commercial real estate space should positively influence rents and cash flows offsetting any potential rise in financing / costs of capital. In Europe, economic conditions are improving with consumer and business confidence at its highest level in a decade, growth prospects in Italy and Spain are getting better and political uncertainty in France has subsided. We believe there's more room to run in Spain and Italy yet public market valuations are beginning to catch up to our forward outlook. Office market rents in Germany, Paris, Stockholm, Madrid and Milan are rising but at a reasonable pace. Industrial fundamentals are strong (save France) with most markets experiencing positive net absorption. The supply of new commercial real estate properties across Continental Europe is low which is good news for retail landlords, yet sales and traffic remain flattish. In the U.K., despite BREXIT, economic conditions are better than expected prompting the Bank of England to consider raising rates. That said, real estate fundamentals are subpar with net effective office rents declining. Demand for industrial space in the U.K. is strong (like other regions) but bricks and mortar retail trends are just okay. We believe the U.K. suffers from a lack of confidence. In Asia, Japanese small and medium business surveys point to an improving outlook, while producer prices are accelerating. We are starting to see improving office rent growth prospects through 2019 in regional cities like Fukuoka (14%), Sendai (10%), Sapporo (6%), Saitama (5.5%), Kyoto (5%) and Osaka Grade A (5%). Although Tokyo is poised to experience new office supply in 2018, 60% of the space is pre-let and vacancy rates are at its lowest level (~4%) in nine years. Logistic and multi-family fundamentals are steady, while cap rates may continue to tick lower as rents improve, especially in regional cities. In Hong Kong, home prices continue to rise despite the government's best efforts to inject new supply into the market. Retail sales seem to have found a bottom, led by a recovery in mainland visitor travel. A number of Hong Kong REITs are exploring selling assets at what may be considerably low cap rates. We believe a successful sale would serve as a positive catalyst for the sector. Office market conditions in Hong Kong are stable with demand leaning away from Central, more towards sub-markets such as Inland East and Admiralty. In Singapore, industrial fundamentals are soft due to higher levels of new supply although public market valuations offer attractive dividend yields. Retail fundamentals are also soft with many REITs focused on asset enhancements as a way to create value. We believe retail operating metrics remain challenging for the foreseeable future. Office market transactions in Singapore have picked up with buildings trading at very low cap rates in the 3% range. We think these prices reflect more about the weight of capital globally than a bet on future rent growth. In Australia, housing markets are marching upwards but with a sense of vigilance. Population growth in Sydney and Melbourne is strong, especially among first time home buyers. Pricing has gotten to the point where developing for-rent product may make financial sense, opening the doors for companies like Mirvac to explore creating an entirely new line of business. We see retail real estate fundamentals as mixed with occupancy rates high, releasing spreads less negative but certain tenants such as pharmacy, jewelry and fashion retailers looking to achieve lower occupancy costs.
Timbercreek Global Real Estate Fund Quarterly Manager Commentary
As at September 29, 2017
MARKET OUTLOOK CONT. Retail acquisition opportunities are scarce with cap rates for high quality assets remaining strong. Office market fundamentals in Melbourne and Sydney are performing better than Brisbane and Perth. Asking rents are rising, net absorption is positive, pre-leasing on new development projects is going well but incentives are stubbornly high, something other global markets are experiencing too.
For more information, please contact Timbercreek Investment Management Inc. 25 Price Street Toronto, ON M4W 1Z1 1.844.304.9967
[email protected] George Ganas Senior Vice President, Global Distribution & Portfolio Specialist 647.203.0533
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