What do the leading agents say?
Direct real estate market
The improving market from end 2013 has given investors confidence for a good start in H1 2014.
CBRE reported total commercial real estate investment in Europe reached €37.9 billion in Q1 2014 – a 18% increase on Q1 2013. The fastest year-on-year growth in Q1 2014 was seen in Austria (+183%), Ireland (+179%), Spain (+132%) and Finland (+103%). The core markets of Sweden (+68%), Germany (+47%) and France (+37%) also showed significant growth compared to Q1 2013. (CBRE research more details here)
While Spain or Ireland are favoured by overseas investors looking for value-add opportunities, UK, Sweden or Germany are considered for their core investment opportunities. However, the German market has seen considerably more activity with UK and US investors now starting to look at larger non-core portfolios with assets in secondary locations.
London recorded its highest-ever quarterly investment total in Q4 2013, exceeding peak levels of 2007, as a result Q1 2014 as been quiet for London due to lack of available investments.Therefore UK investors have started looking outside the London market into regional UK centres as well as into diversifying asset class from office to logistics, business parks and more alternative sectors such as healthcare and hotels. There are perhaps five or six major regional UK cities being targeted by investors, with Manchester and Edinburgh leading the pack. (CBRE UK)
CBRE reports investment into Europe:
|€m||Q1 2014||Q1 2013|
Yields and return
Prime yields have tightened across most of European markets with yield compression spreading to secondary assets in stronger markets, notably the UK where the debt market has improved significantly, followed by Germany. Core markets such as Central London are forecast to generate total returns in the 6-8% range, as currently low prime yields give little scope for yield compression as well as producing a relatively low income return. Prime office yields in London’s West End are now as low as 3.5%-4.0% and City offices 4.5%. (Colliers Research)
CBRE expects cities located in CEE and Eurozone peripheral countries, such as Dublin, Madrid, Moscow, Barcelona and Budapest to be the top performing cities in terms of total return, with an annual average return ranging from 12% to 15% over the 5-year to mid-2019.
IPD UK monthly index shows 3.9% total return over the first three month Jan – March 2014 compared to -1.5% for Equities and 2.5% for bonds. The prime performer was real estate securities with 6.3%. The performance of direct real estate shows that most of the return can be attributed to capital growth driven by yield compression with rental growth filtering through much slower. (IPD Research)
EMEA rental markets
The JLL office-clock shows rental growth slowing down for German cities, but London rents still accelerating over the next 12months. Most other European cities including Milan, Brussels, Paris, Madrid are now at the end of the bottom cycle and rental growth is expected to accelerate later this year assuming the overall Economic climate in Europe keeps improving, with Paris already leading the pack with +3.5%. This is also reflected in Paris increased office demand which was up 19% in Q1 2014. (JLL Research)
Real Estate Securities
Listed real estate markets were the top performer Q1 2014 with EPRA NAREIT Dev’d Europe delivering a 5.8% return.
Since 20th June 2013 newly amended regulation has come into force expanding the scope and application of disclosure requirements for structured finance instruments.
The newly amended CRA3 demands that issuer, originator and sponsor of a structured finance instrument jointly publish information regarding the structured finance instrument on a website to be set up by the European Securities Markets Authority ESMA.
The information to be published is quite extensive and includes detailed credit information and performance of the underlying assets.
It further requires for any public or private structured finance transaction to be rated by two agencies. While this was fairly standard for the public transactions, this is entirely new for private deals.
Altogether this clearly represents another hurdle for securitisation in Europe, with the possible impact of falling even more behind US market growth.
Pension, insurance funds and other investors are looking for alternative asset allocation methods to include real estate as an asset class. According to Consilia Capital and Property Funds Research in a study published by EPRA (European Public Real Estate Association, 2013) real estate securities funds have grown by 68% in AUM between 2007 and 2012 and by 39% in number of funds. This figure also includes CRE ETFs. One key advantage supporting this growth is the liquidity of real estate securities funds in general. This allows investors to react quickly to market changes.
But there are additional advantages choosing a CRE ETF instead of a real estate securities fund. While they offer the same return profiles and volatility, trading costs are significantly lower and liquidity is guaranteed through a registered stock exchange. They are even more liquid allowing for intra-day trading strategies being executed to gain access to very short term returns, for instance due to intra-day differences in trading price vs fund NAV.
CRE ETFs also provide investors with more flexibilities to adjust to market changes in the underlying real estate market by allowing to shorten a specific market. Just like individual shares, CRE ETFs can be sold short. For example an investor may choose a diversified portfolio of real estate stocks or a real estate private equity fund as their core real estate investment, but before they can exit, the market declines. The investor can now short his exposure in the segment using a CRE ETF as a hedge.
A similar strategy is possible for investors in specialist real estate private equity funds, by choosing a special CRE ETF tracking a specific benchmark such as UK industrials, although the hedge might not be as perfect. Options are limited in Europe through the limited amount of specialised real estate property companies. In addition the sector allocation through a basket of listed real estate securities might not be as purist as with a real direct property investment.
Trading CRE ETFs can also be a intermediate strategy for private pooled real estate funds to breach the gap until an appropriate property has been found. Investors will receive a real estate return with the same liquidity as a money market fund at a very low trading cost. There is also no minimum investment amount, because these products are essentially designed for retail investors.
Peak to trough performance during the crisis
During the 2008/2009 liquidity crisis property values in developed markets around the world fell 40-50%.
Also CRE ETFs have been affected and comparing the five European listed funds the pricing index (Jan 2007 = 100) shows the EPRA US Property ETF falling to an index -42 by March 2009. The strongest fall was experienced for the EPRA UK Property ETF to an index value of -64 in August 2009.
The first fund to react to the Lehman bankruptcy was the EPRA Developed market property ETF falling to -24 in Sept 2008, much earlier than any of the other property ETFs. The European investment property ETF IPRP shows less decline (lowest index level of -3 in Sept 2009) than the UK fund. This observation is consistent with actual property price observations in Europe such as Germany and France compared to the UK.
The fund that has performed best during the crisis was the EPRA Asia Property ETF with the lowest index level of 19 in Jan 2009.
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A quick look into 5 LSE listed real estate ETFs confirms Europe’s performance excl the UK is lagging behind due to unresolved economic and political issues.
Over a 3-year horizon the iShares FTSE/EPRA European fund (IPRP) has exhibited a correlation of 82% with the UK EPRA index, while the iShare FTSE EPRA UK fund (IUKP) has shown a close correlation of 85%. Europe’s fiscal austerity and tight credit conditions continue to add stress on the listed real estate sector with the latest casualty German property company IVG facing insolvency.
UK property H1 2013: What do the agents say?
More insight is given by several agents reporting on Q2 2013 real estate investment performance such as JLL http://www.joneslanglasalle.eu/EMEA/EN-GB/Pages/EuropeanOfficePropertyClock.aspx
CBRE Q2 2013 commentary on the UK market:
London’s advantages as a global city in Europe (views by CBRE)
The largest real estate ETFs are generally spread across a wide range of the global real estate industry.
Vanguard REIT Index ETF has benefited from its US weighting and outperformed the S&P DJ Global Property index.
Looking at long term performance consistency, real estate ETFs exhibit similar volatility as real estate securities funds.
Week 5: Understanding risks of real estate ETF strategies
Counterparty risk is most often forgotten by fund investors, however, it exists an investment vehicles that lend out the fund’s constituents (securities lending). This is not only the case for many mutual funds but also synthetic as well as in physical ETFs. And the main providers of physical ETFs in Europe actually use securities lending.
Swaps in Synthetic ETFs
The use of swaps in form of total return swaps in synthetic ETFs causes additional counterparty risk in the structure of all synthetic ETFs. Because synthetic ETFs deliver the performance of the index they track via a swap contract normally with an investment bank as the counterparty whereby it exchanges the performance of such a basket for that of the index counterparty risk is intrinsic to their structure. This means that investors are irremediably exposed – at least theoretically – to the risk that the swap counterparty fails to deliver the performance of the index. While there may be multiple reasons why this may happen, the worst case scenario would be where the swap counterparty simply goes bankrupt. Irrespective of the cause, the ETF investor would be left with the contents of the “substitute basket” as collateral.
It is generally accepted that investors in synthetic ETFs are compensated for taking on swap counterparty risk with the reward of comparatively lower management fees, more accurate tracking vis-á-vis ETFs employing physical replication techniques or when actively managed it enables them to offer strategies such as multiple time the performance of an index.
Currency risk: Investors will most likely find a specific ETF offered in several currencies and different stock exchanges, which means there is no currency at that level. However, at the portfolio level the fund manager has to manage or hedge currency risk at the securities level when investing globally.
There are a series of regulatory measures that providers of synthetic ETFs must comply with as a means of protecting investors against this counterparty risk. Under UCITS rules, for example, the net counterparty risk exposure of an investment fund (i.e. not just ETFs) to any single issuer via a derivative (e.g. swap) cannot exceed 10% of its NAV. In effect this means that 90% of the ETF must be collateralised.
In reality though, the majority of synthetic ETF providers either fully or over collateralise their swap exposure on a voluntary basis, thereby increasing the level of protection afforded to investors. Furthermore, parallel to the voluntary enhancement of collateral requirements, providers of synthetic ETFs have also made major improvements in the area of transparency. For example, online disclosure – mostly on a daily basis – of the composition of the “substitute baskets” has become the norm. This level of transparency helps investors in synthetic ETFs to properly assess risk.
Securities Lending in Physical ETFs
Securities lending is the process of loaning assets to a third party in exchange for a fee. Some, though not all, providers of physically replicated ETFs have securities lending programmes in place with the objective of generating revenues that might partially, or in some cases completely, offset management fees and other sources of index tracking difference. Counterparty risk in this context arises from the fact that the borrowers of these assets might not return them to the ETF manager.
It is important to underline that, unlike the use of swaps for synthetic ETFs, securities lending is not a necessary practice for physical ETFs to deliver the performance of the index they track. Rather, the aim of a securities lending programme is to improve the ETF’s tracking performance. As such, exposing investors to the counterparty risk arising from securities lending becomes a matter of choice by ETF providers.
The level of disclosure around securities lending practices by providers of physical ETFs has improved substantially over the past couple of years. Some may argue it is not yet optimal. However, compared to the secrecy surrounding these practices in the actively-managed mutual fund industry, ETF providers can be fairly described as an “open book”.
In terms of protective measures, it has become common practice for providers of physical ETFs that engage in securities lending to either fully or over collateralise the loans. It is also important to note that while there is no regulatory limit to the amount a fund can lend out, some ETF providers have voluntarily adopted maximum on-loan limits. Some also offer indemnification (i.e. insurance) against potential losses.
Next week 6: Performance ratios
Week 4: The real estate ETF investment universe
The current analysis includes a total 47 real estate ETFs, which are being tracked in terms of their monthly performance, fees, yield and AUM.
After taking over the management of the Ishare universe Blackrock is by far the largest real estate ETF fund manager by number of funds with a market share of c38%, however by AUM Vanguard has a market share of 41% compared to Blackrock (35%). Although Vanguard does not offer many real estate ETFs it is managing the currently largest real estate ETF, which has a market share of 40% alone.
Figure: Fund Universe by Fund Manager
Source: Various, N. Lux, 2013
Most real estate ETFs are listed in the United States (c84%) and another c14% in Europe. As expected, also 68% of the funds have the U.S as their investment target, followed by 27% which focus on global strategies. Only 4% of strategies focus on Europe as an investment market.
Figure: Universe by investment target
Source: Various, N. Lux, 2013
Until now, 98% of real estate ETFs offered, follow a passive replication strategy. Most popular indices are subindices of the FTSE NAREIT or EPRA universe.
Figure: 10 Largest real estate ETFs
Fees are dependent on the fund manager and the investment strategy. Some smaller fund managers might not be as competitive in fees as larger ones. On average management fees are 46bps, with the majority being offered between 40-50bps. Within the same fund manager, the most popular fund will be offered at the lowest fees, while they might increase for certain other strategies. For example global strategies are typically priced slightly higher at 50-60bps.
Figure: 5 most expensive ETFs
Premium/Discount to NAV
ETFs typically trade very close to their NAV. Most real estate ETFs will be trading at a slight discount of 1-20bps. There are currently only 4 real estate ETFs which are trading at a premium.
Figure: 10 largest discounts
While the premium/discount for property shares is often an indicator of company size and liquidity, there is no correlation between ETF fund size and its discount/premium pricing. ETFs with the lowest discounts typically have their primary listing on the NYSE and have their investment benchmark focused on the United States. The few funds currently listed on the LSE appear to have the largest discounts.
Week 5: Performance & standard deviation