After one of the worst years on record for global listed real estate when the index lost a fifth of its value[1], 2023 has started relatively brightly. Global property markets entered June 1.4% lower than the start of the year, but more significantly institutional investors have started allocating capital in Europe and the Nordics – two of last years' weakest performing real estate regions.
Investor sentiment has been heavily influenced by macro factors, particularly inflation and the expected implications of persistently higher prices on the direction and level of future interest rates. This can be seen in last year's broad sell-off across all US property segments, many of which are often weakly correlated. This year's recovery has been similarly widespread, with the exception of office properties where concerns over the strength of the economy and falling demand following the pandemic continue to weigh on performance.
SKAGEN m² is ahead of the global index by 2.2% in 2023, thanks to good stock selection and particularly strong performance from data centres which we bought into ahead of the AI rally. The portfolio continues to perform well with most of our 32 holdings reporting strong results and we have carefully started to increase the fund's risk profile as we become more positive on the real estate outlook versus current valuations.
Once in a decade opportunity
This view appears to be shared by a growing number of asset owners and there are encouraging signs that we may be entering a positive phase of the investment cycle. Several real estate funds have recently raised billions of dollars from those who sense that a combination of rock-bottom property valuations and improving economic conditions should tee-up lucrative future returns.
In April, Blackstone pulled in over $30 billion for the largest ever real estate drawdown fund, highlighting that some of its best investments had previously been made in similar periods of "market volatility and dislocation".
More recently, NREP attracted $4 billion for Europe's largest ever 'value-add' fund which will focus on acquiring Nordic rental apartments, care homes, offices and warehouses from sellers facing financial pressures. Many landlords built large real estate portfolios when interest rates were close to zero and now face much higher costs to refinance properties that have fallen significantly in value, particularly in Sweden.
On the same day KKR announced its first Nordic deal with the acquisition of 1,200 residential units in Finland and the intention to make further purchases in Sweden. The US private equity giant recently claimed that "we are entering a once-a-decade real estate investing environment with the debt capital markets pullback creating attractive new investment opportunities."
Although the possibility to participate in multi-billion-dollar fundraisings is beyond most investors, the opportunities available in public markets look even more compelling. Direct real estate valuations are often stale given the lag in adjusting to market prices, whereas multiples for listed companies have already fallen to financial crisis levels on some metrics.
The valuation disconnect between public and private real estate markets is encouraging some investors to switch from direct to listed vehicles and take advantage of more attractive pricing, particularly as research shows that publicly-traded Real Estate Investment Trusts (REITs) have historically outperformed private real estate during the recession and recovery stages of the economic cycle[2]. Listed real estate is also more likely to benefit from M&A activity at such cheap valuations, with our holdings attracting takeover offers that have benefited unit holders several times in the past few years.
Recovery rewards
Unfortunately, trying to time the market recovery with precision is almost impossible and prices could fall further before they improve. The latest Bank of America fund manager survey showed that allocations to commercial property have fallen to their lowest level since 2008, while short positions against Swedish real estate companies have risen to their highest level in over a decade.
More certain is that we appear close to the end of the current cycle.
Based on net asset values, global real estate is currently priced around 20% below its 30-year average and losses on US REITs are in line with previous recessionary phases. History also shows that listed real estate offers superior returns to conventional equities and direct property once the cycle has turned.
It is also useful to remember that the long-term structural factors underpinning real estate assets remain intact. The market correction means that investors can gain exposure to attractive trends such as aging populations, urbanisation and sustainability at historically low prices.
Cycles tend to turn once investors have sufficient certainty in the future. The recent capital raisings and subsequent deployment are important as they provide transaction multiples that help price discovery. Although we are not yet out of the woods economically, particularly the most leveraged companies, being patient and highly selective are key to achieving the best investment returns. By keeping our focus on resilient but undervalued companies with solid balance sheets in trend-driven segments, SKAGEN m² is well-placed to deliver these when the trees finally clear.
NB: All information as at 31/05/2023 in EUR unless stated
[1] MSCI ACWI IMI Real Estate Index in EUR (-20.6%)
[2] Source: NAREIT