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SIM Sector Presentation. March 20, 2018. Real Estate. Drake Tharp | Pooja Shah | Wesley Smith. Table of Contents. Overview. 1. Overview: Sector Review. Sector Breakdown. Summary.
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SIM Sector Presentation March 20, 2018 Real Estate Drake Tharp| Pooja Shah| Wesley Smith
Overview 1.
Overview: Sector Review Sector Breakdown Summary • The real estate sector includes mortgage companies, property management companies, and REITs. Each of the companies may have a portfolio of residential, commercial, or industrial properties. The companies involvement may be as a developer or operator. • The real estate group is dominated by equity REITs • Required to pay out to shareholders at least 90% of their taxable income • Attractive investment in a low-interest-rate environment, as investors look for income REAL ESTATE • REAL ESTATE COMPANIES • REITS Recent Trends • Urbanization – apartments and office markets are strong • Department store markets face headwinds • Interest rate increases may lead to higher purchase prices for real estate companies, potentially hurting margins • New tax reform could help make REITs more attractive due to taxation of passive income • Developers • Operators
Overview: Companies SIM Holdings Major Players Companies by Market Cap and Assets S&P 500 Portfolio Real Estate 2.6% Source: Company Filings
Overview: Sector Performance Relative Performance YTD S&P 500 -0.2% Sector Performance TTM YTD -5.8% -9.1% Source: Bloomberg
Business Analysis: Property Types • Office • Industrial • Retail • Multifamily • Used for industrial purposes • Small, medium, large • Higher rents and yields generally provided • Longer leases • Used for a store, shopping center, or service business • Higher rents and yields generally provided • Longer leases • Draining business recently • Used for business purposes to produce income • Includes single-tenant and larger buildings • Broken into class A, B, C buildings • Used for multiple separate housing units • Strong cash inflows • Easier to finance, but generally more expensive
Business Analysis: Property Trends Industrial Retail • Negative: e-commerce will encourage brick-and-mortar retailers to consolidate services2 • Neutral: pop-up stores with shorter lease terms may increase in number for retailers interested in showcasing a new product or a seasonal offering • Neutral:Omnichannel retailing is expected to dominate the industry to meet convenience of click-and-collect • Positive: increase in inventory space in the U.S. due to consumer demand of faster delivery rates that leads to increased inventory volume1 • Negative: FDI, which is traditionally high, may decrease due to heightened global regulatory environment under current administration • Positive: shallow-bay buildings will become more popular to satisfy last-mile logistics Office Multifamily • Positive: pro-business spending tax reform may result in increased CAPEX spending for purchases of new or used developments3 • Positive: strong U.S. market growth and employment numbers present unique expansion opportunities for previously lower-performing companies and markets • Positive: evolution of co-working spaces will increase tenant demand • Positive: millennials and empty nesters are pushing urbanization to all-time highs, leading to stronger tenant demand4 • Positive: increase in micro-apartments to lower price on luxurious apartment complexes, leading to stronger supply • Positive: more transaction activity than any other property sector in the U.S. in 2017 Sources: 1BISNOW Research; 2Buxton Company Research; 3 PWC Emerging Trends; 4JLL Research
Business Analysis: Macro Environment Tax Reform Interest Rates2 • Decreased mortgage interest deduction caps will likely cause home prices to drop • 20% deduction for REIT dividends provides more favorable investment opportunity than corporations • First-year depreciation deduction in personal property increases to 100% before 2023 • Increased interest expenses hurt real estate market because of large debt portfolios with floating rates • Jerome Powell announced 3-4 rate hikes in 2018 • Mild correlation between real estate and interest rate movements, but generally inverse Sources: 1PWC Emerging Markets; 2Bloomberg
Business Analysis: Business Life Cycle Real Estate Market1 Cover Analysis • Most real estate markets are in expansion phase, soon to be approaching the hypersupply phase • Overall, industry is expected to enjoy a long period of expansion before it hits hypersupply • Experts in real estate expect a peak similar to the recent financial crisis around 2024 Sources: 1Harvard University Cover
Business Analysis: Competitor Landscape Industrial Retail Office Multifamily
Business Analysis: Opportunities and Risks Opportunities Risks • The Federal Reserve is expected to increase short-term interest rates • Potential black swan events could lead to a major market correction, similar to that in early February 2018 • Most real estate lives on debt to the tune of 50% or higher, being a highly-levered asset class • Properties with longer-term leases offer more interest rate risk • Hotels and apartments are in the best position to take advantage of a growing economy • Industrial sector continues to enjoy the largest valuations relative to price of the major property types • $170bn of U.S. CMBS loans maturing through the end of 2018 present opportunities for sophisticated investors1 • Increased migration to and development of secondary markets, such as Philadelphia, Atlanta, Austin, Dallas, and San Diego Sources: 1Ares Market Insights
Financial Data - REITs S5REITS index’s current sales and earnings growth rate are lower compared to past.
Free Cash Flow S5REITS index generated negative cash flow in five of last nine years.
Free Cash Flow Yield S5REITS index has lower free cash flow yield compared to S&P 500 index
Dividend Yield S5REITS index has higher dividend yield compared to S&P 500 index.
Valuation: Absolute Basis Large fall over the last year due to rate hikes
Valuation: Relative to S & P 500 S & P 500 Real Estate: each metric about 5-10% below S & P
Valuation: Sub Sector Performance Retail has done the worst, Some REITS value down 94% Valuation varies by sub industry, however no industry has performed well.
Technical Analysis Possible to see resistance because the sector has fallen below lower band of moving averages
Recommendation Since we are currently underweight in real estate for the portfolio, we recommend that we stay underweight. Negatives: We believe that interest rates will continue to rise which will undercut companies that are used as bond proxies. Higher interest rates raise the cost of borrowing for commercial and homeowners Online shopping hurts retail space Positives: Growth in economy/corporate tax cut: office space demand Higher wages/lower unemployment: housing/apartment demand, retail demand, increased need for inventory space. Currently the negatives outweigh the positives as real estate demand tends to lag a growing economy.
