Insight Article

•

décembre 11, 2023

Perception Versus Reality in Listed Real Estate: More Than Meets the Eye

décembre 11, 2023

Perception Versus Reality in Listed Real Estate: More Than Meets the Eye

Insight Article

Perception Versus Reality in Listed Real Estate: More Than Meets the Eye

décembre 11, 2023

KEY TAKEAWAYS

Negative headlines about commercial real estate (CRE) neglect nuance and variations.
There’s a wide array of fundamentals within CRE sectors and secular drivers impacting longer-term growth prospects.
The office sector is uniquely challenged by new debt and equity capital sourcing.
CRE banking system contagion fear is overblown and underlying collateral for majority of loans is strong.

CRE has been navigating a treacherous path amid rising interest rates, macroeconomic uncertainty, and stubborn inflation. To make matters worse, emerging from the COVID-19 pandemic, changes in how we live, work, and play are exacerbating problems for some types of CRE. Nonetheless, we believe some of these macroeconomic dynamics are improving and there are opportunities for investors who are willing to look more closely.

A deeper look at sector returns within listed real estate highlights this dichotomy. The U.S. REIT market is an example of how not all CRE is created equal. While sectors such as offices may continue to struggle, many forms of real estate, including data centers, single-family rental housing, and seniors housing are thriving (Display 1).

DISPLAY 1

FTSE Nareit All Equity REITs Index YTD Returns as of October 31, 2023

Source: FTSE Nareit and Morgan Stanley Investment Management
Returns provided in USD terms. Past performance should not be construed as a guarantee of future performance. It is not possible to invest in an index. Groupings are based on how the investment team views the real estate securities universe and do not reflect official groupings. Provided for illustrative purposes only.

CRE continues to generate negative headlines, largely because of concern over debt capital markets and the office segment. Notably, we believe the old fears that CRE could take down the banking system are overblown. Banks are better capitalized now than during the Global Financial Crisis and, as per Display 2, have manageable exposure to CRE. Moreover, even the underlying delinquencies within CRE are low compared to prior levels.

DISPLAY 2

Bank CRE Loan as % of Total Loan Exposure by Country

Source: Moody’s Analytics and IMF for U.S. data as of March 2023; Morgan Stanley Research for European data as of Sept. 30, 2023, or last reported based on publicly available data from listed banks.

In our view, the concern about office fundamentals and valuations, and offices’ ability to tap the debt markets, is valid. However, the concern that office loans will cause banks to implode is not based on reality. Office real estate comprises a fraction (approximately 18%¹ in Europe and 17% in the U.S.²) of CRE loans, making overall office loan exposure as a percent of total loans in the low single digits, while offices represent approximately 27% of U.S. CMBS exposure.³ Looking more broadly at loans in the U.S., multifamily residential real estate comprises nearly half of all CRE mortgage debt. In most cases, multifamily residential is better positioned because it lacks core secular pressures that hinder some other types of real estate due to the need for shelter, creating a better store of value, and immunity from obsolescence. Additionally, as the workplace of tomorrow takes hold, even within the more challenged office sector—which represents a mere 3.3% of the U.S. index and 13.7% of the global index⁴— there will be winners: building quality, sustainability, and location will be more important than ever.

Return to Office?
Office vacancy rates vary greatly across the globe, as do utilization rates of buildings that are technically occupied.⁵ Vacancy is relatively stable in many central business district (CBD) locations in Europe, hovering around 8% in London’s West End and 3% in the Paris CBD. Meanwhile, vacancy rates in most of the U.S. continue to increase, with New York at 14% and San Francisco at 20% (See Display 3).

DISPLAY 3

Office Vacancy Rates by City

Source: Costar. PMA, Morgan Stanley Real Estate Investing (MSREI) Strategy, November 2023.

Moreover, office utilization rates are around 60% to 65% in European cities with an upward bias, and have stagnated and maxed out at about 50% in coastal U.S cities, as shown in Display 4.

DISPLAY 4

Office Utilization Rates by City

Source: JLL, MSREI Strategy, as of September 2023.

However, even within more challenging cities, there are examples of real fundamental strength within trophy office buildings. For example, Owen Thomas, CEO of Boston Properties (BXP, the largest publicly traded developer, owner, and manager of premier workplaces in the U.S.) said on the company’s third quarter 2023 earnings conference call that: “For the last 11 quarters, net absorption for the premier (office) segment was a positive 8.1 million square feet versus a negative 30.8 million square feet for the balance of the market, and asking rents are 44% higher for the premier workplace segment. Including two buildings undergoing renovation, 94% of BXP’s CBD space is in buildings rated by CBRE as premier workplaces, which has been important in driving the increasing office attendance statistics in our buildings and is a critical differentiator for BXP in the leasing marketplace.” Globally, the office market is also moving toward shorter leases with more flexibility for tenants. This increases operating risk, but offers opportunities to strong platforms to gain market share and extract higher cash returns from their portfolios.

Globally, the office market is also moving toward shorter leases with more flexibility for tenants. This increases operating risk, but offers opportunities to strong platforms to gain market share and extract higher cash returns from their portfolios.

Where is the Opportunity?
While the office sector continues to pose challenges for investors due to difficult fundamentals and continued value impairment, there are select opportunities within the sector. However, more importantly, there are multiple subsectors of real estate with fundamental strength and opportunity, including:

DATA CENTERS: Data growth facilitating the digital economy and new technologies, including artificial intelligence (AI), continues to provide a robust backdrop for new data center demand. New supply is more limited than it has been historically, due to power availability challenges which have resulted in a favorable environment for landlords to increase rents. We expect these challenges to remain a critical issue going forward, and advancements in AI have been an incremental demand driver to the sector. We believe data center real estate investment trusts (REITs) provide a compelling opportunity for investors not only over the short term, but potentially for the next decade, as the sector is likely to benefit from the strongest long-term secular growth drivers within the REIT universe.
SENIORS HOUSING: The necessity-based nature of seniors housing demand is anticipated to insulate fundamentals from macro headwinds. Labor shortages and expense pressures that were a problem throughout the COVID-19 pandemic, are dissipating. The aging U.S. population, as evidenced by the growth within the 80-plus age cohort, is expected to serve as a significant demand driver for seniors housing through the remainder of the decade, with a compound annual growth rate in excess of 4% through 2030.
SINGLE-FAMILY RENTAL HOUSING: The undersupply of single-family homes in the U.S. coupled with higher mortgage rates should serve as a long-term growth driver for the sector. The U.S. has a shortage of approximately five million homes versus what is needed to house the current population. Additionally, home ownership affordability remains low with monthly differentials of buy versus rent at historic spreads. Lack of affordability increases demand for single-family rental homes. As the population continues to increase, demand within the sector is expected to remain strong. We believe this broader thematic trend of the undersupply of housing will fuel fundamentals for years to come.

Security and Sector Selection is Vital as Valuations Remain Attractive
Valuations remain attractive with equity multiples and price/net asset value trading at or close to trough valuations globally and in each region (see Display 5), although security and sector selection are key to outperformance. In the current environment, we are underweight offices, but do have select exposure to best-in-class office landlords. Additionally, we are overweight data centers, seniors housing, and single-family rental housing. We are actively managing subsector exposures and closely monitoring valuations as we seek to identify the real estate securities with the best total expected returns for clients.

DISPLAY 5

Valuations by Region

Source: UBS Global Real Estate Research, Datastream.

Conclusion
The sectoral composition and differentiation among the REIT universe is vital when thinking about and analyzing the underlying risk/ reward profile and performance of real estate securities, and helps to create opportunities for active managers within listed real estate investing. While offices may continue to be featured prominently and negatively in headlines, they represent a small and declining part of the investment universe. In contrast, we believe there are compelling opportunities in many other forms of CRE. The Morgan Stanley Investment Management (MSIM) GLRA Team seeks to take advantage of opportunities presented by secular and cyclical trends and attractive valuations as we ultimately strive to identify the real estate securities with the best forward total returns.

DOWNLOAD PDF

¹ European Central Bank Banking Supervision as of August 17, 2022.
² Mortgage Bankers Association as of April 28, 2023.
³ Mortgage Bankers Association as of September 30, 2022.
⁴ As of October 31, 2023. U.S. Index represented by FTSE Nareit All Equity REITs Index; Global Index represented by FTSE EPRA Nareit Developed Extended Index. Groupings are based on how the investment team views the real estate securities universe and do not reflect official Index provider groupings.
⁵ The buildings are occupied in that they are being leased, but the office is not being utilized.

Laurel Durkay

Managing Director,

Head of Global Listed Real Assets

Simon Robson Brown

Managing Director,

Head of European Listed Real Estate

Christopher Fremantle

Executive Director,

European Listed Real Estate

Nicholas D’Ambrosio

Analyst,

U.S. Listed Real Estate

Idées liées

Insight Article

Climate Change is Here…

20 sept. 2024

Learn why now is an important time to embrace sustainability in real estate.

Insight Article

A Compelling Opportunity in REITs

15 août 2024

Given the Fed is expected to start cutting interest rates in 2H24, we believe now is an excellent time to consider an allocation to REITs.

Insight Article

After Trough NAV Discount Comes Trough NAV

23 juil. 2024

The trough in European listed real estate NAV discounts has preceded the trough in NAVs usually by six to nine months. We think this time is no different.

Risk Considerations

The value of investments may increase or decrease in response to economic, and financial events (whether real, expected or perceived) in the U.S. and global markets. The value of equity securities is sensitive to stock market volatility. Real Estate Risk: The risks associated with ownership of real estate and the real estate industry in general include fluctuations in the value of underlying property, defaults by borrowers or tenants, market saturation, decreases in market rents, interest rates, property taxes, increases in operating expenses and political or regulatory occurrences adversely affecting real estate. Real estate investment trusts (REITs) are subject to risks similar to those associated with the direct ownership of real estate and they are sensitive to such factors as management skills and changes in tax laws. Concentration Risk: Concentration in a single region may make the portfolio more volatile than one that invests globally.

IMPORTANT DISCLOSURES

Past performance is no guarantee of future results. The returns referred to herein are those of representative indices and are not meant to depict the performance of a specific investment.

There is no guarantee that any investment strategy will work under all market conditions, and each investor should evaluate their ability to invest for the long-term, especially during periods of downturn in the market.

A separately managed account may not be appropriate for all investors. Separate accounts managed according to the particular Strategy may include securities that may not necessarily track the performance of a particular index. Please consider the investment objectives, risks and fees of the Strategy carefully before investing. A minimum asset level is required.

For important information about the investment managers, please refer to Form ADV Part 2.

The views and opinions and/or analysis expressed are those of the author or the investment team as of the date of preparation of this material and are subject to change at any time without notice due to market or economic conditions and may not necessarily come to pass. Furthermore, the views will not be updated or otherwise revised to reflect information that subsequently becomes available or circumstances existing, or changes occurring, after the date of publication. The views expressed do not reflect the opinions of all investment personnel at Morgan Stanley Investment Management (MSIM) and its subsidiaries and affiliates (collectively “the Firm”), and may not be reflected in all the strategies and products that the Firm offers.

Forecasts and/or estimates provided herein are subject to change and may not actually come to pass. Information regarding expected market returns and market outlooks is based on the research, analysis and opinions of the authors or the investment team. These conclusions are speculative in nature, may not come to pass and are not intended to predict the future performance of any specific strategy or product the Firm offers. Future results may differ significantly depending on factors such as changes in securities or financial markets or general economic conditions.

This material has been prepared on the basis of publicly available information, internally developed data and other third-party sources believed to be reliable. However, no assurances are provided regarding the reliability of such information and the Firm has not sought to independently verify information taken from public and third-party sources.

This material is a general communication, which is not impartial and all information provided has been prepared solely for informational and educational purposes and does not constitute an offer or a recommendation to buy or sell any particular security or to adopt any specific investment strategy. The information herein has not been based on a consideration of any individual investor circumstances and is not investment advice, nor should it be construed in any way as tax, accounting, legal or regulatory advice. To that end, investors should seek independent legal and financial advice, including advice as to tax consequences, before making any investment decision.

The indexes are unmanaged and do not include any expenses, fees or sales charges. It is not possible to invest directly in an index. Any index referred to herein is the intellectual property (including registered trademarks) of the applicable licensor. Any product based on an index is in no way sponsored, endorsed, sold or promoted by the applicable licensor and it shall not have any liability with respect thereto.

This material is not a product of Morgan Stanley’s Research Department and should not be regarded as a research material or a recommendation.

The Firm has not authorised financial intermediaries to use and to distribute this material, unless such use and distribution is made in accordance with applicable law and regulation. Additionally, financial intermediaries are required to satisfy themselves that the information in this material is appropriate for any person to whom they provide this material in view of that person’s circumstances and purpose. The Firm shall not be liable for, and accepts no liability for, the use or misuse of this material by any such financial intermediary.

This material may be translated into other languages. Where such a translation is made this English version remains definitive. If there are any discrepancies between the English version and any version of this material in another language, the English version shall prevail.

The whole or any part of this material may not be directly or indirectly reproduced, copied, modified, used to create a derivative work, performed, displayed, published, posted, licensed, framed, distributed or transmitted or any of its contents disclosed to third parties without the Firm’s express written consent. This material may not be linked to unless such hyperlink is for personal and non-commercial use. All information contained herein is proprietary and is protected under copyright and other applicable law.

Eaton Vance is part of Morgan Stanley Investment Management. Morgan Stanley Investment Management is the asset management division of Morgan Stanley.

DISTRIBUTION

This material is only intended for and will only be distributed to persons resident in jurisdictions where such distribution or availability would not be contrary to local laws or regulations.

MSIM, the asset management division of Morgan Stanley (NYSE: MS), and its affiliates have arrangements in place to market each other’s products and services. Each MSIM affiliate is regulated as appropriate in the jurisdiction it operates. MSIM’s affiliates are: Eaton Vance Management (International) Limited, Eaton Vance Advisers International Ltd, Calvert Research and Management, Eaton Vance Management, Parametric Portfolio Associates LLC and Atlanta Capital Management LLC.

This material has been issued by any one or more of the following entities:

EMEA:
This material is for Professional Clients/Accredited Investors only.

In the EU, MSIM and Eaton Vance materials are issued by MSIM Fund Management (Ireland) Limited (“FMIL”). FMIL is regulated by the Central Bank of Ireland and is incorporated in Ireland as a private company limited by shares with company registration number 616661 and has its registered address at 24-26 City Quay, Dublin 2, DO2 NY19, Ireland.

Outside the EU, MSIM materials are issued by Morgan Stanley Investment Management Limited (MSIM Ltd) is authorised and regulated by the Financial Conduct Authority. Registered in England. Registered No. 1981121. Registered Office: 25 Cabot Square, Canary Wharf, London E14 4QA.

In Switzerland, MSIM materials are issued by Morgan Stanley & Co. International plc, London (Zurich Branch) Authorised and regulated by the Eidgenössische Finanzmarktaufsicht ("FINMA"). Registered Office: Beethovenstrasse 33, 8002 Zurich, Switzerland.

Outside the US and EU, Eaton Vance materials are issued by Eaton Vance Management (International) Limited (“EVMI”) 125 Old Broad Street, London, EC2N 1AR, UK, which is authorised and regulated in the United Kingdom by the Financial Conduct Authority.

Italy: MSIM FMIL (Milan Branch), (Sede Secondaria di Milano) Palazzo Serbelloni Corso Venezia, 16 20121 Milano, Italy. The Netherlands: MSIM FMIL (Amsterdam Branch), Rembrandt Tower, 11th Floor Amstelplein 1 1096HA, Netherlands. France: MSIM FMIL (Paris Branch), 61 rue de Monceau 75008 Paris, France. Spain: MSIM FMIL (Madrid Branch), Calle Serrano 55, 28006, Madrid, Spain. Germany: MSIM FMIL, Frankfurt Branch, Grosse Gallusstrasse 18, 60312 Frankfurt am Main, Germany (Gattung: Zweigniederlassung (FDI) gem. § 53b KWG). Denmark: MSIM FMIL (Copenhagen Branch), Gorrissen Federspiel, Axel Towers, Axeltorv2, 1609 Copenhagen V, Denmark.

MIDDLE EAST:
Dubai: MSIM Ltd (Representative Office, Unit Precinct 3-7th Floor-Unit 701 and 702, Level 7, Gate Precinct Building 3, Dubai International Financial Centre, Dubai, 506501, United Arab Emirates. Telephone: +97 (0)14 709 7158).

This document is distributed in the Dubai International Financial Centre by Morgan Stanley Investment Management Limited (Representative Office), an entity regulated by the Dubai Financial Services Authority (DFSA). It is intended for use by professional clients and market counterparties only. This document is not intended for distribution to retail clients, and retail clients should not act upon the information contained in this document.

This document relates to a financial product which is not subject to any form of regulation or approval by the DFSA. The DFSA has no responsibility for reviewing or verifying any documents in connection with this financial product. Accordingly, the DFSA has not approved this document or any other associated documents nor taken any steps to verify the information set out in this document, and has no responsibility for it. The financial product to which this document relates may be illiquid and/or subject to restrictions on its resale or transfer. Prospective purchasers should conduct their own due diligence on the financial product. If you do not understand the contents of this document, you should consult an authorised financial adviser.

U.S.: NOT FDIC INSURED | OFFER NO BANK GUARANTEE | MAY LOSE VALUE | NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY | NOT A DEPOSIT

Latin America (Brazil, Chile Colombia, Mexico, Peru, and Uruguay)
This material is for use with an institutional investor or a qualified investor only. All information contained herein is confidential and is for the exclusive use and review of the intended addressee, and may not be passed on to any third party. This material is provided for informational purposes only and does not constitute a public offering, solicitation or recommendation to buy or sell for any product, service, security and/or strategy. A decision to invest should only be made after reading the strategy documentation and conducting in-depth and independent due diligence.

ASIA PACIFIC
Hong Kong: This material is disseminated by Morgan Stanley Asia Limited for use in Hong Kong and shall only be made available to “professional investors” as defined under the Securities and Futures Ordinance of Hong Kong (Cap 571). The contents of this material have not been reviewed nor approved by any regulatory authority including the Securities and Futures Commission in Hong Kong. Accordingly, save where an exemption is available under the relevant law, this material shall not be issued, circulated, distributed, directed at, or made available to, the public in Hong Kong. Singapore: This material is disseminated by Morgan Stanley Investment Management Company and should not be considered to be the subject of an invitation for subscription or purchase, whether directly or indirectly, to the public or any member of the public in Singapore other than (i) to an institutional investor under section 304 of the Securities and Futures Act, Chapter 289 of Singapore (“SFA”); (ii) to a “relevant person” (which includes an accredited investor) pursuant to section 305 of the SFA, and such distribution is in accordance with the conditions specified in section 305 of the SFA; or (iii) otherwise pursuant to, and in accordance with the conditions of, any other applicable provision of the SFA. This publication has not been reviewed by the Monetary Authority of Singapore. Australia: This material is provided by Morgan Stanley Investment Management (Australia) Pty Ltd ABN 22122040037, AFSL No. 314182 and its affiliates and does not constitute an offer of interests. Morgan Stanley Investment Management (Australia) Pty Limited arranges for MSIM affiliates to provide financial services to Australian wholesale clients. Interests will only be offered in circumstances under which no disclosure is required under the Corporations Act 2001 (Cth) (the “Corporations Act”). Any offer of interests will not purport to be an offer of interests in circumstances under which disclosure is required under the Corporations Act and will only be made to persons who qualify as a “wholesale client” (as defined in the Corporations Act). This material will not be lodged with the Australian Securities and Investments Commission.

Japan: For professional investors, this material is circulated or distributed for informational purposes only. For those who are not professional investors, this material is provided in relation to Morgan Stanley Investment Management (Japan) Co., Ltd. (“MSIMJ”)’s business with respect to discretionary investment management agreements (“IMA”) and investment advisory agreements (“IAA”). This is not for the purpose of a recommendation or solicitation of transactions or offers any particular financial instruments. Under an IMA, with respect to management of assets of a client, the client prescribes basic management policies in advance and commissions MSIMJ to make all investment decisions based on an analysis of the value, etc. of the securities, and MSIMJ accepts such commission. The client shall delegate to MSIMJ the authorities necessary for making investment. MSIMJ exercises the delegated authorities based on investment decisions of MSIMJ, and the client shall not make individual instructions. All investment profits and losses belong to the clients; principal is not guaranteed. Please consider the investment objectives and nature of risks before investing. As an investment advisory fee for an IAA or an IMA, the amount of assets subject to the contract multiplied by a certain rate (the upper limit is 2.20% per annum (including tax)) shall be incurred in proportion to the contract period. For some strategies, a contingency fee may be incurred in addition to the fee mentioned above. Indirect charges also may be incurred, such as brokerage commissions for incorporated securities. Since these charges and expenses are different depending on a contract and other factors, MSIMJ cannot present the rates, upper limits, etc. in advance. All clients should read the Documents Provided Prior to the Conclusion of a Contract carefully before executing an agreement. This material is disseminated in Japan by MSIMJ, Registered No. 410 (Director of Kanto Local Finance Bureau (Financial Instruments Firms)), Membership: the Japan Securities Dealers Association, The Investment Trusts Association, Japan, the Japan Investment Advisers Association and the Type II Financial Instruments Firms Association.