One of the perks of being in an education institution again is the ability to attend certain talks held on campus. One such talk held last week was the Mapletree Annual Lecture. The lecture held annually by Mapletree Investments is open to the public but with limited slots.
Professor Todd Sinai of Wharton Business School conducted this year’s lecture entitled Recent Trends in Real Estate Markets and Some Implications for REIT Investors. Prof Sinai chairs the Real Estate department at Wharton Business School.The lecture also had an accompanying panel discussion comprising of 3 other panelists:
- Choo Oi Yee, Managing Director, Head of Singapore Global Banking, UBS AG
- Mark Chu, Managing Director, Co-Head of Asia Pacific, Eastdil Secured
- Michael Smith, regional CEO Europe and America, Mapletree Investments
Although his lecture was US-centric, I think the insights presented are globally relevant. So here’s my summary of the lecture for your reading pleasure.
Prof Sinai started with a macroenvironment analysis, looking specifically at 2 related indicators that are traditionally associated with property / REIT valuations – Interest rates and Capitalisation rates.
Low interest rate environment
As we all know, low interest rates are here to stay. Central banks globally have been very accommodating, with some central banks having negative interest rates. The US Fed has also put rate hikes on a pause in recent months as well.
Keeping interest rates low makes it easy to borrow money cheaply. As a result, the required return on investments is also lowered. To understand this, I’ll bring back a graphic I made for my Why Size Matters for REITs article.
If your cost of capital is lower (borrowing cost in this case), more potential investments are cashflow positive to you. The effect of this is that people will be able to buy properties at high prices and result in…
Compressing Cap rates
Capitalisation rates refer to the Net Property Income of a property divided by the Market Value of the property. A low capitalisation rate usually indicates overvaluation.
As you can see here, Cap Rates in the US are close to 2008 lows.
Prof Sinai is of the view that we have pretty much squeezed as much income out of US properties. As such, any further compression in Cap Rates is purely based on hype / FOMO.
We also know that real estate is a cyclical market with booms and busts. As such, he feels that we should be looking to de-risk by tweaking our capital structures (be it REITs or personal debt), namely by:
- Having longer debt maturities – You don’t want to be in a position of having to refinance your debt in a recession. Just ask AIMS APAC REIT during the GFC.
- Lowering your leverage – This makes you more resilient should the value of properties decline in a downturn. Value declines will cause gearing increases and make you at risk of breaching loan covenants.
Real Estate Trends
The 2nd part of the talk was quickly covered by discussing the Prof’s views on certain trends in Real Estate.
Evolution of Retail
Coming from a country where retail is very much threatened by Amazon and eCommerce, I was very much surprised by his view about the death of Retail in the US. He actually holds the view that retail is currently undergoing evolution, rather than obsolescence.
He feels that the future of retail will become largely experiential, something Singapore retail REITs have already anticipated and rebalanced towards. This is seen from the increase in proportion of F&B outlets, Gyms, Class studios and other experiential activity centres that are in malls now.
Some interesting reasons given by Prof Sinai include:
- Humans are inherently social creatures, doing everything alone at home is something not a lot of people can do.
- Various tech inventions were predicted to lead to a decrease in social interactions. These concerns failed to materialise. Some examples include the Telegram, Telephone and the Internet.
Death of offices?
Surprisingly, Prof Sinai was rather bearish on Offices. He feels that the advent of technology and flexible work arrangements, the need for large corporate offices has diminished as employees spend less time in the office than ever.. The rise in hot-desking and WeWork is an indicator of this.
As a result, Office REITs may need to find a way to evolve themselves to keep up with this trend.
Rise of Logistics Properties and Datacentres
Prof Sinai also emphasized the need to follow market trends to determine the types of real estate that will be in favour in the future. He used the rise in demand for Logistics Properties and Datacentres as examples of 2nd order thinking. The rise in eCommerce and the Internet drove demand for these 2 types of properties.
Opportunities and Risks
Much of the panel discussion was centred around 2nd and 3rd order thinking from emerging trends. Some of the interesting trends that may drive demand for new property types include:
- Same day delivery of groceries – Cold storage properties?
- Shrinking home apartments – Self storage properties?
- Smaller homes mean a need to store stuff externally?
- Aging population – Lifescience research properties? Senior Living?
- Institutional interest increasing in Lifescience research properties. Some listed REITs in the US focused on this niche.
- Cost of labour (qualified nurses) and regulatory requirements are impediments to Senior Living profitability.
My Personal Takeaways
It was an insightful 1.5 hour discussion on the outlook and trends in Real Estate. Some of my personal takeaways are:
- Top-ish market means a need to play defense. Focus on REITs with lower debt maturities and lower gearing.
- We should minimise personal leverage at this point of the cycle.
- 2nd and 3rd Order thinking is needed if you wish to invest in new emerging real estate trends. The panel discussion reminded me of missing out on the Datacentre trend and a discussion I had on investing in Weed growing properties in the US.
Much to think about for my own portfolio.
What do you think of the Real Estate trends described above? Do you think that we are in a peak Real Estate market? Do let me know your thoughts.