Global property securities rose in October, with the UK the top performer, as financial markets welcomed Washington’s mid-month government debt deal, according First State’s latest snapshot of the sector.
The US Canada and Singapore regions followed the UK showing, while Australia and Japan underperformed.
First State Investments notes that since the Fed’s decision in September to delay tapering, longer-term US interest rates have fallen. Accordingly, October saw outperformance from higher-yielding REITs, such as those in the health care and net lease sectors, which tend to benefit most from lower rate expectations.
The US hotel sector outperformed based on healthy third quarter earnings growth, including some positive surprises, and positive guidance for 2014. Industrial real estate demand continued to pick up, with face rents moving decisively higher.
US apartment REITs underperformed due to concerns of decelerating rent growth. However, First State says forecasted US apartment rent growth is still attractive and sector valuations remain “compelling”.
Continental European property securities, meanwhile, rose as Spain emerged from recession, reporting GDP growth of 0.1% for the third quarter of 2013, after nine consecutive quarters of contraction. The investment manager notes that investor demand for keenly-priced Spanish property assets is growing, indicating that the bottom of the property market may be in sight.
Certainly UK retail REIT Intu Properties, formerly known as Capital Shopping Centres, is betting on Spain’s economic recovery, having recently engaged in a joint venture to acquire a 75,000 square metre property in Spain for €162 million.
First State cautions, however, that business sentiment across eurozone, as measured by October’s purchasing manager’s index, remains lacklustre. It reckons any European economic upturn will be “shallow”.
Elsewhere, Japanese property securities notably declined in October, although First State believes market fundamentals there remain sound. Office vacancy levels for Tokyo’s five central wards fell to 7.9% in September, the lowest level since late 2009.
In the residential market, higher-than-forecast condominium supply in the Greater Tokyo area was met with strong demand in September; 83.5% of condominiums were sold during the first month after launch.
Notable recent changes for First State’s own Global Property Securities fund include the initiating of a position in US retail REIT Macerich based on its attractive valuation, high-quality portfolio, and favourable geographical exposure, which is concentrated in California, Arizona, and the US North East.
The fund has sold its holdings in Post Properties, a US apartment REIT focused on the Sun Belt (the South and South West), 
First State Global Property Securities fund has returned 105% over five years; 28% over three years; and 7.5% one year.
Mixed outlook as tapering looms
On market outlook and positioning for its fund, First State notes that given the upcoming change in leadership at the US Fed and the temporary US budget and debt deal, the consensus view is that QE is now likely to continue into to 2014.
It adds: “Low interest rates coupled with accelerating and healthy GDP growth is an ideal environment for REITs. However, we remain cautious: QE is due to be reduced unless growth rates disappoint, implying that the current environment is unlikely to remain intact.”
First State believes shorter lease-term, more economically sensitive sectors, including hotel, apartment, industrial and mall REITs, appear to be better positioned than more defensive, longer lease-term sectors, such as the net-lease and health care REITs, for an environment of rising interest rates and improving economic growth.
The investment manager is cautious towards continental Europe, where it believes the operating environment remains “challenging”. It maintains an underweight position on the region.
However, it has a favourable view of property companies with exposure to London as a result of which its fund is overweight UK: “The London West End and City office markets remain vibrant, and encouraging signs are emerging as the UK economy recovers.”
First State also has a positive view on Hong Kong property developers and Australian REITs, as they boast generally healthy balance sheets, investment grade property portfolios and defensive business models: “Valuations are relatively attractive, with a number of stocks trading at a discount to Net Asset Value, and the earnings growth outlook for these regions appears favourable.”
The investment manager is “cautiously positive” on the Japanese property sector, which it believes should continue to benefit from the macroeconomic stimulus program being carried out by the Japanese government and the Bank of Japan.
It adds: “We expect [Japan] property fundamentals to continue to recover, albeit at a gradual pace. Pent-up demand for property investment and the expectation of rental growth are likely to continue to drive capitalisation rates down in the medium term, driving up prices. However, we remain selective and disciplined with our stock selection in Japan, following the strong performance seen so far this year.”
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