The director of asset allocation research at Baring argued flows into the asset class “are likely to be significant and, in all probability, have only just begun.”
As investors hunt for areas to invest in that do not come with additional volatility, Mahon predicts many will reallocate their bond portfolios into more alternative assets. “We expect property to be very much on their list and European REITs to be the main beneficiary,” he said.
In particular, he sees key investment opportunities in German and northern eurozone REITs and other property related securities against the European Central Bank’s ultra-low interest rate regime, which has made European government bonds less palatable to investors.
“Our returns from this basket have outpaced the wider European equity markets,” Mahon said. “While the basket has experienced some volatility, most notably in August 2015, it has been far steadier than the overall market. In fact, we used the sell-off in 2015 to add to these names.”
Coupled with the fact that fundamentals are improving, vacancy rates are falling and dividend yields remain in-line with the wider European market, Mahon says “there is no reason to believe the market has got ahead of itself.”
Crucially, he does not believe the earnings potential of European REITs will be disrupted by politically charged events like the upcoming Italian referendum or further fallout from the Brexit vote.
“We expect the earning power of real estate companies to be improved significantly as their old outstanding debts are slowly replaced by much lower cost obligations,” he remarked. “This should allow these companies to boost their earning power simply by the passage of time in a lower yield environment. On top of this, the usual process of rent reviews acts to slowly increase the rental value particularly in the strong growing economies of Northern Europe.
“This means that the real estate theme has a more predictable earnings potential than the market,” he continued. “The geopolitics of Europe should not alter the earnings picture for these companies. In the context of greater predictability for REITs it would be rational for the market to ascribe a premium valuation to the sector, similar to that witnessed for many years in the UK before the recent EU Referendum.”
