Lazard Global Real Estate Securities
US Real Estate Indicators Report
OCT
2014
The real estate investment trust (REIT) market was once again volatile in October as investors tried to figure out whether they favored risk, or the lack
thereof. During the month, the market’s view was decidedly low risk (a reversal from September) as investors grappled with heightened concerns over
global economic weakness. As such, REITs recorded their best monthly performance in three years, returning 8.7%1 and over 600 basis points (bps)
ahead of broader equities (based on the S&P 500 Index). REITs have now returned almost 23% for the year, handily ahead of the S&P 500 Index
by close to twelve percentage points. As we have discussed in prior reports, the extreme reaction in a month like October is not unexpected given the
market’s recent behavior of oscillating between viewpoints. Of note, October witnessed the end of six years of monetary stimulus measures in the United
States. This passed with little fanfare, ironically, as investors were more focused on deflation rather than inflation.
Much of the October outperformance can be attributed to a general flight to safety and yield investments amid a host of macroeconomic concerns
(Europe’s malaise, China’s slowdown, etc.). However, these concerns continue to highlight the underlying fundamental strength of US commercial real
estate which is not only driving REIT earnings, but driving property values as well. Third-quarter earnings further supported our view of strong fundamentals to the upside, with 91% of REITs reporting either meeting or beating earnings estimates, and 57% raising 2014 guidance.2 In particular, retail
REITs posted strong numbers and accounted for many of the 2014 guidance increases, while apartment REITs had record-high occupancy levels and
a re-acceleration in rent growth. With still-limited new supply across sectors, all the core sectors should be able to post property-level growth in excess
of inflation through 2015. It is worth noting that even the “worst” performing sector (industrials) is still up 17.3%1 year to date, and in the month of
October, six of the property types posted double-digit returns.
Meanwhile, capital markets remain open for listed real estate companies, evidenced by a number of new REIT IPO listings and the more than $72
billion raised in public market capital by REITs so far this year3. Global equity capital has bolstered underlying property values by favoring the United
States over other countries due to the country’s organic population growth, immigration-based growth, transparent corporate environment, rule of law,
and many other factors. Globally, there is approximately $408 billion of capital available (up 15% since year-end 2013) for real-estate investment.
US Real Estate Market Returns
(%; cumulative)
ALL REITs¹
Equity
REITs4
1 Month
YTD
1 Year
3 Years
5 Years
8.7
22.9
18.5
53.8
137.3
141.4
9.0
23.6
18.2
53.4
REIT Preferred5
0.7
18.4
15.8
27.5
81.8
S&P 500
2.4
11.0
17.3
71.8
116.4
1 Month
YTD
1 Year
3 Years
5 Years
11.5
34.1
28.1
34.3
168.2
Office
9.7
22.5
18.9
45.8
100.5
Regional Retail
8.6
25.9
23.9
62.6
212.6
Local Retail
11.6
25.8
18.1
61.7
132.8
Industrials
11.9
17.3
10.0
62.9
120.0
Self Storage
12.2
29.4
17.2
78.4
237.2
Health Care
12.0
27.7
12.1
47.4
110.0
Hotel
11.1
26.5
30.1
85.7
164.3
5.1
18.5
18.0
39.3
77.1
US Real Estate Market Returns by Property Type
(%; cumulative)
Apartments
Mortgage
As of October 31, 2014
For illustrative purposes only. The performance quoted represents past performance. Past performance is not a reliable indicator of future results. This is not intended to
represent any strategy or product managed by Lazard. The indices are unmanaged and have no fees. One cannot invest directly in an index.
Source: NAREIT, FTSE, Standard and Poor’s
RD22659
2
Listed Real Estate Market Performance
Cumulative Returns (Indexed to 100)
(Index, October 31, 2014=100)
150
REITs
S&P 500
REIT Preferred 5
NCREIF 6
125
100
75
Dec 12
Mar 13
Jun 13
Sep 13
Dec 13
Mar 14
Jun 14
Sep 14
As of October 31, 2014
For illustrative purposes only. The performance quoted represents past performance.
Past performance is not a reliable indicator of future results.
Quickly gaining back ground lost in September, REITs posted their
best monthly performance in three years, up 8.74%. After falling
victim to fears of higher interest rates during September, REITs
benefited from the market becoming more concerned about global
economic weakness thereby flooding into safe haven and yield
assets. REITs have returned 22.9% year to date, and have further
extend the lead over the S&P 500 Index, which has increased nearly
12% for the year. While REITs have regained much of the ground
that was lost in 2013, the asset class has still underperformed
broader equities by approximately 16% since then-Fed Chairman
Ben Bernanke began discussing financial tapering on May 22, 2013.
Notably, the REIT preferred market increased another 0.7% during
September and is now up 18.4% for the year, driven primarily by a
10-year US Treasury yield which has declined by approximately 70
bps since December 31, 2013.
Source: Bloomberg
Real Estate Fundamentals
Property Net Operating Income (NOI) Growth
(%)
12
2012
2013
2014E
2015E
2016E
2017E
9
6
3
0
Apartments
Industrials
Reg Mall
Office
Community
Retail
Hotel
Earnings-growth expectations have been generally stable over the
past three months, with little actual or anecdotal evidence to suggest an uptrend or a downtrend. As the sector digests third-quarter
earnings which just ended, we expect a slight upward change to
2014 expectations and a more rigorous focus on 2015 expectations.
Currently, 2015 growth expectations range from approximately
7.0% in the hotel sector to 3.6% in the community retail sector,
with all core sectors demonstrating NOI growth above inflation
(based on current levels) for the next few years.
As of October 31, 2014
Estimated data are not a promise or guarantee of actual results and are subject to change.
Source: Green Street Advisors
Capital Markets Activity
Rolling 3-month US Commercial Real Estate Transaction Volume
($B)
(%)
8.50
160
Transactions [LHS]
8.00
Cap Rate [RHS]
120
7.50
7.00
80
6.50
40
0
6.00
5.50
2005
2006
2007
2008
As of October 31, 2014
Source: Real Capital Analytics
2009
2010
2011
2012
2013
2014
Real estate transaction activity continued its upward climb in
September (transaction data lags by one month) to an annualized
$362 billion, 12% above September 2013 levels. In general,
transaction volume remains around 2006 levels. Average
capitalization (cap) rates have compressed substantially from
the same time last year (down approximately 115 bps) with the
10-year Treasury yield only down marginally (12 bps) over the
same period. Therefore, the real estate cap-rate spread to the
10-year Treasury yield has narrowed by approximately 100 bps as
compared to last year.
3
Listed Real Estate Valuations
Premium/Discount to Underlying Net Asset Value (NAV)
Due to the price run-up in October, REITs traded at a 6% average
premium to long-term NAV, which is slightly above the long-term
average. While elevated, the premium is down by approximately
10 percentage points from the May 2013 peak, even though real
estate fundamentals have strengthened over that time. The specter
of higher interest rates may still loom over the market (as was
evidenced during September’s swoon), but the combination of the
improving fundamentals and private market capital flows to property assets continues to support underlying property values.
(%)
30
LT Average
0
-30
Average Percent Prem/Disc
-60
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
As of October 31, 2014
Source: SNL Financial
REIT-Implied Capitalization Rate Spread to BBB Bonds
While narrowing slightly from September, the spread between
REIT implied cap rates and Corporate Baa bonds remains north
of 200 bps. This spread is slightly higher than one year ago, though
down by approximately 60 bps from earlier in 2014. This spread
compression is directionally similar to that in the private markets,
where the average cap-rate spread to the 10-year Treasury yield is
215 bps below peak spread levels in 2012.
(%)
15
Implied Capitalization Rate
10
5
BBB Bond Rates
Spread
0
-5
1997
1999
2001
2003
2005
2007
2009
2011
2013
As of October 31, 2014
Bond ratings based on Bloomberg Fair Value USD Composite (BBB) 10-year Index
Source: SNL Financial
Price-to-Funds From Operations (P/FFO)
(x)
25
20
LT Average
15
10
5
Average P/FFO Multiple
0
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
As of October 31, 2014
Source: SNL Financial
October’s average REIT P/FFO ratio of approximately 17.7 is inline with levels at the same time last year. However, as with broader
equities, the sector is trading above long-term averages (15.7).
Given the still-supportive fundamental backdrop and better growth
expectation for 2014 and 2015 earnings, the premium to historical
averages is understandable at this point in the real estate cycle and
suggests a fairly priced REIT market. Average earnings growth projections of 8% to 9% in 2014, strong transaction volume, and little
sign of impending property fundamental weakness should continue
to underpin valuations.
Note: P/FFO is the standard REIT equivalent of the price-toearnings (P/E) ratio.
US Real Estate Indicators Report
Notes
1 As measured by the FTSE NAREIT All-REITs Index.
2 Source: Bank of America Merrill Lynch
3 Source: SNL Financial
4 Source: FTSE NAREIT All Equity Total Return Index
5 Source: Wells Fargo Hybrid and Preferred Securities REIT Index
6 NCREIF – Property Index (reported quarterly)
Important Information
Published on November 13, 2014.
This report is being provided for informational purposes only. It is not intended to be, and does not constitute, an offer to enter into any contract or investment agreement with respect to any
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as of the published date, and are subject to change.
The performance of investments in real estate and real estate related securities may be determined to a great extent by the current status of the real estate industry in general, or by other factors (such as interest rates and the availability of loan capital) that may affect the real estate industry, even if other industries would not be so affected. The risks related to investments in realty
companies include, but are not limited to: adverse changes in general economic and local market conditions; adverse developments in employment; changes in supply or demand for similar or
competing properties; unfavorable changes in applicable taxes, governmental regulations, and interest rates; operating or development expenses; and lack of available financing. An investment
in REITs may be affected or lost due in part to the fluctuation with the value of the underlying properties of the investment. An investment in REITs may be affected or lost if the REIT fails to comply with applicable laws and regulations, including tax regulations, specifically, the failure to qualify as a REIT under the Internal Revenue Code of 1986, as amended.
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changes in government administration, and economic and monetary policy. Small- and mid-capitalization stocks may be subject to higher degrees of risk, their earnings may be less predictable,
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