By Matein Khalid: Chief Investment Officer and Partner at Asas Capital
Real estate equities are the best performing sector on Wall Street in 2019, with the benchmark Nareit index up 17% as I write. This is no surprise. The financial markets have bid up the valuations of sectors with no exposure to US-China trade tensions. The plunge in the US Treasury yield curve has been a steroid shot for real estate investment trusts (REIT’s) as it reduces their costs of borrowing and raises the present value of their rental portfolio cash flows. A 4% plus yield is compelling in a world when the yield on the ten-year US Treasury note (and the S&P 500 index) is 2.10%. Fed Fund/Eurodollar futures markets now price in a 50 basis point rate cut in the July or September FOMC conclaves. Refugees from FANG shares terrified about the antitrust sword of Damocles over Google will continue to rotate to real estate.
After all, the US economy’s 3% GDP growth, Goldilocks inflation, 50-year lows in the unemployment rate and robust wage growth anchor smart money flows into real estate equities. Yet I must warn my readers that valuations are no longer dirt cheap. Some property markets face a supply glut or secular decline (suburban shopping malls as 70,000 stores close) and individual names can be gutted due to mismanagement or excessive leverage even in a bull market. Real estate is unquestionably not a defensive, low beta sector, as some of its acolytes contend.
While my bullishness on US REIT’s since December 2018 has been vindicated, I am far more selective about specific property micro-markets, investment themes, corporate balance sheet leverage and acquisition strategies. As always, my focus remains on the hottest growth segments of the world property markets – data center, E-commerce, senior housing and refrigerated warehouses/cold storage. These are sectors which simply do not exist in the GCC stock exchanges, where illiquid brick and mortar real estate will continue to fall in prices as rents decline, expat tenant demand contracts, geopolitical risk rises, chronic supply gluts define most segments and exorbitant service charges fleece investors. Dumb money that pays 50% developer profit margins is destined to hemorrhage money in the brick and mortar off plan Ponzi rollercoasters of the Gulf. That much, at least, is certain.
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Technology is redefining the economics of property investing, as it is has done since the invention of the telegraph, the internal combustion engine and the automobile in past centuries. Big Data, driverless cars, robotics, E-commerce, E-mobility, artificial intelligence etc. will all have a seismic impact on property investing in the next decade.
I have long been an investor in global data center REIT’s listed in New York. Why? The tenants in Big Tech are the crème de le crème of Silicon Valley’s corporate credits. Huge upfront infrastructure costs makes supply limited and complex fit outs mean long life leases with rent escalation clauses embedded. After all, a data center landlord needs to provide world class fiber optics networks, the digital back bone of E-commerce and cloud computing. This is an oligopolistic industry with only six listed companies that dominate the global data center market.
In property investing, I detest generic sectors with no barriers to entry, pricing power or insulation from inevitable supply gluts – like homes and offices. Retail? As obsolete as horse carriages, black and white TV and brontosaurus. This is a lesson leveraged punters learnt the hard way in the GCC brick and mortar property bear market. This makes data center REIT’s irresistible to me, where landlords can raise prices, tenants cannot leave and growth metrics are viral. In economics, natural oligopolies always print long term cash for investors especially as new cyber-security protocols raise barriers to entry. Net operating income for a well-managed data center REIT is one third its construction/fit-out cost. This property micro-market can well deliver 15-20% CAGR in the next decade, as it has done for me since 2013.
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Senior housing is another no-brainer growth theme in property investing. The 76 million US Baby Boomer generation, the biggest, richest cohort in human history, has begun to retire. The “golden oldies” (aged 65 or over) population will double in the next two decades, as happened in Japan. This makes a compelling argument to invest in senior housing landlords.
Industrial/logistics REIT’s are also a no brainer in the Age of Amazon, the Death Star of retail stores and retail brands worldwide. I have made no secret of my attraction to Prologis, the world’s largest listed industrial REIT that owns 780 million square feet of state-of-the-art logistics/warehouse assets.
Americold Realty (symbol COLD) is up 50% since its IPO in 2018. COLD is a red-hot property theme as there is a chronic shortage of refrigerated warehouses worldwide. This is a stellar 25% margin business. Amazon-Whole Foods and food delivery services make this a secular growth puppy. If space was the final frontier for Star Trek, online groceries (2% now, 15% of all goods in a decade) is the final frontier in E-commerce. Cold storage is a play on the consumer backlash against food preservatives and non-organic food that only benefits oncologists. The average US cold storage warehouse is 34 years old at a time when demand is set to surge for cold storage real estate – hello? We sure wuz born at night – only not last night!