This week’s Investment Soundbite Q&A from FundCalibre is with Rogier Quirijns, co-manager of the Cohen & Steers European Real Estate Securities fund. He discusses the broadening sub-sectors in real estate, the impact of inflation-linked rentals and tells us where he is currently finding opportunities in the sector.
(Recorded 21 June 2023)
Real estate securities is quite a broad sector. 10+ years ago we would’ve just thought of office, retail and industrial, but the sector’s broadened out over that period, would you agree?
Yes, definitely. The US is more advanced in areas like towers and data centres and in Europe, logistics has come a long way. But I think another sector I have to mention is [the] self-storage sector. It’s a sector that is very interesting from a long-term growth perspective, for income, rental growth and from a supply/demand perspective.
Like most assets in 2022 the real estate market had a challenging period as rates went up with inflation. Is it just inflation and those rising rates which caused that more challenging period over the last year or so?
The main challenge has been that we’ve come out of quantitative easing into quantitative tightening and, at the same time, we’ve had a significant inflation impact. Going from a deflationary environment to 2% – 3% inflation would’ve been perfect. But we all know that didn’t happen. We went from 3% to 5%, from 5% to 10% and even 15% inflation in some locations. So, inflation overshot, and I think that is where the whole market came into some kind of headwind. That meant that interest rates had to increase at the fastest pace we’ve seen in 30 to 40 years. That had a negative impact on real estate, especially the listed market first. The listed market will correct the quickest, and then the private market will correct later and at a slower pace. So, yes. Inflation and interest rates have been the main headwind over the year.
You mentioned that inflation can actually benefit real estate?
If you look at Europe, both the UK and the continent, there’s a fair amount of rental contracts linked to inflation. The question then is can you pass on 12% inflation? I think that’s getting a little bit tricky. So generally, what we see is they pass on around 6% to 8% inflation. But in Sweden for instance, they pass on 10% inflation.
The second question is, is that sustainable? And I think this is where we do a lot of work of course as specialists, and we think yes, in certain cities, certain sectors, it is sustainable.
The headwind is, of course, the higher interest rates, and then it’s more about the balance sheets of the companies. Do they have a conservative balance sheet? Do they have long dated debt?
Do you worry about recession? Or do you think actually, across Europe, that might just be avoided and maybe on a valuation basis we’ve already had some of the pain?
I think at this point I’m less worried about the recession to a certain extent because I think for us, recession is a little bit necessary now. You see what the central banks are doing also to reduce inflation. So, I think it’s important that inflation peaks and growth somewhat comes down. And then there’s room for the interest rate to stabilise, if not come down a little bit.
And I think our sector is less cyclical than other equities. We’ve got generally long lease contracts and the inflation link in there. So, I think if that happens, a recession, I’m not that negative for our asset class. We could, or probably would, be buying more German residential. Prime retail is even doing relatively well, giving out good dividend yields, and probably healthcare or so instead of buying more offices.
How is the fund positioned today?
Since Covid, we’ve had a stronger focus on pure value which is mostly retail. As you know, a lot of people didn’t like retail because of the obvious e-commerce reason, but I think we are past that station. I think we all know there’s physical retail and there’s digital retail. So, if I look at the retail part and especially the prime shopping centres in Europe, we get around an 8% dividend yield, and rents can increase with inflation. So, if the company has a good balance sheet, I think that’s a good product, also compared to bonds. It’s relatively stable even if there’s a recession, I would say. So, I think that’s good.
Then we have certain growth aspects in the portfolio, like self-storage. That generally makes a very good total return, and has very strong pricing power. Look at the long-term returns of those self-storage companies, you might find them on the internet. I think that’s a bit cyclical. So, if the recession comes, they might pull back. We have an overweight on the sector but not a big one. So, if that happens, I would definitely look to increase that weight at the time when the price is right. We always look at relative value. So, I think that’s another one that makes me confident about how to deal with the uncertainties that are coming towards us.
Then the big question is about German residential in Europe. The balance sheets are not great, but it’s extremely cheap. So, we added a little bit there and I would say that’s a little bit more opportunistic investing. We think it’s oversold and we have a company that we’ve never owned before during the bull market, but we thought now it makes sense to own it. It’s so cheap. We paid 12.5 times the rent. So that’s around an 8% cap rate for German residential – that’s far below replacement costs. The company is selling assets at a relatively good price. And I think that’s where we get relatively cheap access to an extremely defensive asset class. So, an extreme defensive cash flow which is not fully index linked, but I think once the inflation peaks there’s more room for rental growth to catch up with inflation again.
Tell us more about German residential property
I would say the difference between the UK and the rest of Europe is mostly regulation. Germany is regulated with the mietspiegel [a rent index] although, you know, the mietspiegel also goes up if there’s a demand and supply imbalance, which there is. I mean the whole of Europe, including the UK, has a huge shortage of residential [property], of course.
I think German residential is a little bit more defensive versus the UK PRS market, generally because of all the regulation – the rents are relatively low, probably 25% below market.
Which areas are genuinely exciting you as we look forward over the coming years?
I think for now, at this time in the cycle, I would say retail. Why? I think it’s a relatively high yield. So, your implied cap rate is around 7%. You have growth, you have indexation, it’s not over rented, but that means you go for the higher quality retail and more on the continent than in the UK. I think in the UK, I’m a little bit more worried here with the mortgage system and the impact of higher interest rates on the consumer. Ican also find a retailer on the continent that has a 10% to 12% dividend yield. Very convenience focused – so, for your daily shopping, an average basket of around €10 per customer. So, I think very inflation proof, very recession proof.
Listen to the full interview here:
