REIT Insight NEWSLETTER SEPTEMBER In this month s REIT Insight the two major themes of focus include:

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1 REIT Insight NEWSLETTER SEPTEMBER 2013 REIT Insight is a monthly market commentary by Resource Real Estate's Global Portfolio Manager, Scott Crowe. It discusses our perspectives on major events and trends in real estate securities. REIT Insight is a viewpoint from an investment practitioner with a unique focus on both publicly traded and non-traded REIT markets. In this month s REIT Insight the two major themes of focus include: 1. NON-TRADED REITs 2013 is on track to break records for raising capital Returns of recent non-traded REIT listings Recessions and oversupply cause property downturns, not interest rate downturns 2. TRADED REITS Our take on recent Fed comments Europe turns a corner Outlook

2 NON-TRADED REITs 2013 is on track to break records With $12.9 billion raised through August 31 and projections of $18 billion by yearend, the non-traded REIT sector has outstripped its previous record of $11.7 billion, set in If the $18 billion increase is achieved and all indications say that it will be the sector s market cap will grow by 20% year over year, toward $100 billion. This compares favorably with the larger exchange-traded REIT sector, which is expected to edge up by 5%. The growth drivers are familiar: investors in a low interest-rate world seeking income and capital stability. We believe that the factors underpinning this should be in place for some time, which implies continued strong growth for raising capital into next year. A question of liquidity recent listings We have increasingly seen non-traded REITs find an exit through the public markets, either by listing outright or by being acquired by an affiliate. A number of recent listings have been impacted by the uncertainty surrounding the direction of interest rates (our views on the latest Fed comments can be found in the next section), as shown in the figure below. Recent non traded REIT listings performance Source: Bloomberg This decline has left investors with a difficult decision with respect to liquidating positions that they have held in non-traded REITs following their listing. As we are investors in both publicly traded and non-traded markets, our clients sometimes ask us how to determine whether liquidation is the right choice. Naturally, that is a question that must be answered in accordance with their individual criteria, time frame and liquidity needs. In the table below, we show relative performance and some yardsticks of valuation for the REITs that have come to market so far this year REIT Insight September 2013

3 A market commentary by RRE s Real Estate Securities Global Portfolio Manager, Scott Crowe REIT Insight Recent non-traded REIT listings valuation metrics Source: Bloomberg; RRE estimates. As of September 27, The impact of interest rates, recessions and supply on property cycles Real estate values and interest rates are closely tied in investors minds, but that link can be tenuous. While higher interest rates can make other investment strategies more appealing, recessions and oversupply have historically played a much bigger role in real estate returns, as the figure below shows. Property cycles and interest rates Source: Bloomberg; NCREIF; RRE estimates The left Y axis measures real estate returns on a 12-month rolling average from 1978 through June 2013, and the right Y axis similarly measures 10-year Treasury bond yields. The blue line tracks real estate returns through several recessions, culminating in the crash of The red line shows the 10-year Treasury bond yield and the blue shading shows periods of rising interest rates. The inconsistency of a correlation between the two over time is stark. REIT Insight September

4 NON-TRADED REITs This is because interest rates play only a partial role in commercial real estate returns. More impact arises from supply and recession. When excess supply intersects with a recession, property values decline, sometimes precipitously, as they did in the early 1990s. The crash of 2008 was a different matter altogether its scope and severity threatened the collapse of all financial markets. Real estate, which had enjoyed a multi-year runup in prices, saw a significant correction. Construction came to an abrupt halt. Supply, which was already low, as the figure below indicates, tightened further. New Supply of Real Estate Historically Low Source: Green Street Advisors Today s environment is typified by low supply and growing demand. Construction starts are only now beginning to pick up, but it takes years to erect buildings. Meanwhile, many buildings are at or near capacity, and landlords are seeing a return to growth in rents. In our opinion, now is an excellent time to buy real estate. 4 REIT Insight September 2013

5 TRADED REITs Our take on recent Fed comments While underlying property markets tend to be resilient to interest rate fluctuations, REITs (which are traded daily on public exchanges) may continue to work through an adjustment phase to an anticipated increases in rates. We saw evidence of this in May. When Federal Reserve Chairman Bernanke discussed tapering, he said he would slow the Fed s bond-buying program once the economy was on solid footing and employment gains were steady. A significant correction in REIT prices followed as 10-year Treasury yields increased on expectations that quantitative easing would end sooner than expected. However, Bernanke recently clarified his position in September as Treasury yields approached 3%, indicating discomfort with the markets consensus that yields would reach 4% in An increase of that magnitude would have had a further significant impact on REIT prices, and we are pleased that it is, for now, off the table with yields stabilizing in the ~2.6% area. Europe turns a corner Despite Europe s challenges, our analysis shows we are now seeing the beginnings of a sustainable economic recovery. Underlying commercial real estate values have stabilized, debt is available and spreads are wide. As such we have made our first investment into Europe, through Corio NV, a Dutch retail company that owns shopping centers across Western Europe. We will add selectively to Europe as well as Asia as opportunities arise. European REIT discount to NAV Note: we have excluded Europe s largest REIT (Unibail) from the analysis, given its large index weight and substantial NAV premium Source: JP Morgan; RRE estimates REIT Insight September

6 Outlook We are in the midst of a correction, with REIT prices down about 15% from their highs earlier this year. Uncertainty regarding the outlook for interest rates and investor overreaction to market events has driven this decline, but overlooks improving fundamentals. This presents investors with a great opportunity to enter this real estate cycle at a discount. The economy is improving and interest rates are normalizing at a bit below 3% which is excellent news for real estate values. For this reason, we have increased our weighting to publicly traded REITs, targeting some of the most oversold sectors, including health care and net lease. We also focus on several real estate securities markets, which gives us access to the widest opportunity set, creates diversification, and enables us to access investments with lower correlations and higher yields. Scott Crowe, Global Portfolio Manager Scott Crowe is the Global Portfolio Manager for the Resource Real Estate Global Opportunities Fund and the Resource Real Estate Diversified Income Fund. Previously, he was the lead Global Portfolio Manager for Cohen & Steers, where he led the investment and research team of over 20 portfolio managers and analysts. Mr. Crowe was accountable for over $10B in FuM across the global, international and emerging market portfolios. Prior to this, Mr. Crowe held the position of Head of Global Real Estate for UBS Equities Research where he built and managed the US REIT division while leading a global team of more than 40 analysts. Scott began his career at Paladin Property Securities and was also an Associate Lecturer at the University of Technology Sydney. Scott holds an Honors Finance Degree from the University of Technology Sydney and a Bachelor of Commerce from the University of NSW/National University of Singapore Walnut Street, 18th Floor Philadelphia, PA