Global REITs (as per EPRA/NAREIT Developed Rental Index Net TR, USD; “Benchmark”) closed the month up 2.48% (2.31% in ZAR), outperforming global bonds (J.P. Morgan Global Bond Index), global equities (MSCI World Index) and the S&P 500 (SPX Index) which achieved returns of -1.01%, 2.17% and 1.87%, respectively. By region UK REITs finished tops closing the month 8.06% higher, followed by European REITs achieving a 3.71% total return. Australian and Hong Kong REITs performed the worst, returning -3.32% and -1.72% respectively.

Global markets continue to be affected by geopolitical issues (as a drag) and monetary policy support. Investor sentiment is being impacted by the US-China trade war, Brexit concerns, protests in Hong Kong and the recent Saudi Arabia/US-Iran tensions. The US-China trade war seemed to tone down slightly towards the end of the quarter as both countries agreed to resume talks in October. Boris Johnson maintained his 100% loss record as Prime Minister as Members of Parliament voted against his request to shut down parliament after the Supreme Court judged his initial request to prorogue (shutdown) Parliament as ‘unlawful’. There seems to be no end in sight for protests in Hong Kong which have recently become more violent and destructive. The question now is whether the Chinese government will intervene and, if so, will this affect Hong Kong’s status as Asia’s premier financial centre?

During the quarter, 16 central banks around the world attempted to cushion a potential downturn by cutting rates. The US Federal Reserve (“Fed”) cut rates twice (once each at the July and September FOMC meetings) as expected and the European Central Bank (ECB) delivered a broad-based easing package which included a further cut of the key policy rate (deeper into negative territory) and a resumption of asset purchases. Economies in North America, Australia and developed Asia (Japan, Singapore, Hong Kong among others) appear relatively healthy, but as rates are cut and QE is extended, we are concerned that central banks have less tools in the ‘recession-fighting-toolbox’ when a recession does in fact occur.

In the pursuit of ‘relative safety’ and ‘reliable income streams’ during current volatile times, investors have increased allocations to REITs, perceived to be a more defensive asset class due to stable cash flows generated from long term leases. Furthermore, compared to widely tracked indices such as the S&P500, the earnings growth gap has converged with REITs. General equities are expected to show lower earnings growth of around 2.5% for 2019 (weighted average 2019 EPS growth excluding real estate) compared to 6.4% for real estate. The defensive qualities of REIT earnings relative to general equities makes a better risk adjusted proposition at this point in the cycle. As a result, global REITs have reached record highs and achieved year-to-date USD total returns of 21.20%, compared to US equities, global equities and global bonds which achieved returns of 20.55%, 18.16% and 6.27%, respectively. Direct property fundamentals in major economies like the US, some parts of Europe, Asia and Australia are likely to improve over the next two years which will likely translate into higher LFL rental growth and bottom line FFO or EPS growth (relative to 2018). However, given the strong performance year to date it has become more important to be selective in sector and stock picking.

At a 3.9% forward dividend yield REITs show good relative value to the lower bond yields; but prices don’t move in a straight line and a breather could be on the cards at current valuations. Earnings growth remains robust and lower funding rates (mainly Europe and Australia) and limited supply provide upside risk to our expected 6% earnings growth from the sector. We expect around 6% in total returns from the sector from current levels.