Friday 15/02/2019

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Listed real estate: what can we expect for 2018?

Senior Equity Analyst

Despite volatile interest rates, 2017 was a good year for Eurozone listed property with the EPRA Eurozone posting a total return of +16.5% whereas shares only show a return of +9.2%. After years of good performance and long-term rates remaining volatile, what can we expect for 2018 ?

“Growth in most European countries expected above 2%’
Macro fundamentals remain very decent with GDP growth in most European countries expected above 2% despite some positive factors (cheap euro, low commodity prices) gradually fading away. This strong growth does not result in undue inflationary pressure with underlying inflation remaining subdued at 1%. Differences between countries are substantial with strongest growth to be found in Luxembourg, The Netherlands, Nordics and CEE countries. Growth is positive for most property segments.

“We expect the ECB to gradually reduce its asset purchases before raising interest rates for the first time well into 2019”
Policymakers have been cautiously looking to gradually move away from the current zero interest rate environment and prevent asset bubbles but are eager to avoid premature policy tightening. At this stage, we expect the ECB to gradually reduce its asset purchases to zero before raising interest rates for the first time well into 2019. Market-driven long-term rates are more difficult to assess but we believe their possible negative impact does not need to be overstated as most REITs extensively hedge their interest rate risk and average cost of debt (incl. legacy debt) at most companies remains well above the marginal cost of new debt. In other words, even when assuming rents rising moderately, lower cost of debt in 2018 remains likely at most companies as new debt is closed and expensive legacy debt expires. Additionally, higher rates a likely to go together with economic growth and/or higher inflation. The latter is especially positive for healthcare where long leases with no break option are the rule.

“Belgian elderly appear as rather ‘young’ and healthy with one of the highest healthy life expectancy in Europe”
Demographics is another driver for real estate in general (population growth) and especially for healthcare property which is driven by an increasingly older population in Europe with ageing expected to peak in most countries in 2040-2050. Most ‘grey’ countries measured as a proportion of 65+ people are Germany and Southern countries. Belgium appears to have a rather ‘young’ population but with large regional discrepancies. Another trend is the rising proportion of very old people (>80 years) with highest levels to be expected, again, in Germany but also in The Netherlands and France. Belgian elderly appear as rather ‘young’ and healthy with one of the highest healthy (read autonomous) life expectancy at 65 in Europe (> 10 years). In other words, some countries will have a need for ‘heavy’ elderly care infrastructure such as nursing homes whereas other countries will need more ‘light’ structures such as assisted living flats. Ageing also has an impact on retail with several studies suggesting that elderly people value convenience retail, especially for daily & frequent purchases such as groceries.

“E-commerce is disruptive but not a retail apocalypse"
E-commerce is traditionally seen as negative for retail. Obviously e-commerce is disruptive (price transparency, convenience, choice) but not a retail apocalypse as it affects differently retail formats, different retail segments (food vs. say, travel agencies) and has its limits (lack of trust, geoblocking, ‘free delivery’ gradually becoming a paid service). In addition, retail landlords have not stayed idle and have optimized their retail offering (increase e-commerce resilient sectors), their locations (retailers are more selective but still need to be present in main retail areas), client knowledge (smart/connected shops) and client experience (maximize convenience and/or fun). Actually, some e-retailers such as Amazon have started to open physical stores in order to cope with versatile and demanding customers.

“Listed real estate offers good value for money”
Despite good market performances in 2017, listed real estate remains attractive in our view with earnings yield stable at 6% on average i.e. well above bond yields. We expect earnings of the companies we cover to rise by 7% in 2018; main drivers are portfolio growth (+4% for our coverage, double digit growth in logistics & healthcare), operating expenses (fixed costs are optimized as a company grows), financial expenses (here too, the more you grow, the more new cheap debt).
All in all and despite insisting noises on rates, listed real estate offers good value for money and should be driven by a benign macro context, attractive valuation and good operational prospects.