AMP Capital Listed Real Assets Investment Insights 2013 · experience, understanding, networks and...

AMP Capital Listed Real Assets Investment Insights 2013

This publication is designed to share our investment ideas and insights with respect to listed real assets with you.

The themes and associated pieces have been developed and written by our investment professionals.

They cover the listed real assets of listed real estate and listed infrastructure and highlight our strength across these assert classes and our unified investment house approach.

The articles range from thoughts on asset allocation to individual asset classes. For example, global real estate investment trusts (REITs) have provided strong returns over the past year and we examine whether they can continue this year.

We hope you find this booklet interesting and insightful.

AMP CapitalAMP Capital is one of the world’s leading and oldest investment houses with a strength in real estate and infrastructure investment.

Ranked in the world’s top 15 real estate managers*

Ranked among the world’s top eight infrastructure managers**

One of the world’s earliest institutional infrastructure investors and managers

- 25 year track record

- executed more than 100 infrastructure transactions

- one of the first infrastructure debt investors

Extensive experience – our clients benefit from experience gained from investing in and managing real assets through market cycles

Experts – as one of the world’s first infrastructure investors, our people and their experience in direct and listed infrastructure sets us apart

Innovation – we access innovative investment opportunities through our global network of relationships in power, utilities, airports and public private partnerships

ESG leadership – we are recognised externally as an industry leader of Environmental, Social and Governance (ESG) integration practices in the infrastructure asset class

Proven – 160-year pioneering heritage provides an enviable track record, expertise, experience, understanding, networks and deep investment insights

As at 30 June 2013.

AMP was founded in 1849, is the largest real estate manager in Asia Pacific (ANREV 2011) and has won several awards for its offerings (Asia Assess Management magazine 2011 and 2012).

* Infrastructure ranking #8 global in Towers Watson Global Alternatives Survey 2012

** Real estate Asia ranking ANREV Fund Managers Asia Survey and globally #15 by pension AUM according to Financial Times & Towers Watson Global Alternatives Survey 2012

1 // AMP CAPITAL INVESTMENT IDEAS – QUARTER THREE 2013

Contents

Listed infrastructure 2

Case for investing: Listed infrastructure 2

The outlook for listed infrastructure 3

Listed real estate 5

Case for investing: Listed infrastructure 5

Seven keys to investing in listed real estate 6

The outlook for listed real estate 8

Ensure there is real estate in your REITs 10

Can global listed real estate continue its strong performance? 12

// 2 AMP CAPITAL INVESTMENT IDEAS – QUARTER THREE 2013

Global listed infrastructure securities invest in essential assets such as toll roads and utilities, as well as airports, hospitals and schools. Below are some of the reasons for investing in this asset class.

Generally less volatile than other asset classesInfrastructure assets are often built or regulated in such a way that they face little or no competition. These strong monopolistic qualities provide the asset class with defensive characteristics and mean they are generally subject to less market volatility than other asset classes.

In addition, because infrastructure assets often have their profits guaranteed by long-term contracts or regulation, returns tend to be relatively predictable over time regardless of the economic or business cycle. These long-term agreements often last decades and in some cases into perpetuity. For investors, this provides extremely good visibility for revenues, cash-flows and ultimately, dividends.

The chart below shows that since 1990, global listed infrastructure has generated higher returns with less volatility than a number of other asset classes.

Global listed infrastructure has provided higher returns with

lower risk than a number of asset classes

Source: Bloomberg and AMP Capital. Annualised quarterly observations from 1990 – 2012.

As at 30 June 2013. Past performance is not a reliable indicator of future performance.

A good hedge for inflationInflation is a major threat to investors. When the general price level of goods and services goes up, an investor’s purchasing power diminishes.

Revenues from infrastructure assets are often linked to inflation, either via a regulated return framework or through contractual arrangements. This means infrastructure assets can provide investors with a hedge against the effects of inflation on long-term cash-flows. Some agreements allow an infrastructure company to pass through any commodity expense and interest costs incurred on the debt the company holds. These clauses can serve to insulate investors from uncertainties like commodity price volatility, interest rate increases or inflation.

Higher dividend payments than global equities and global bondsThe chart below shows the historic dividend yield of global listed infrastructure. While yields have diminished in recent times, the asset class is still offering higher dividend yields than global equities and global bonds. Infrastructure companies are generally able to offer investors higher dividend payments as operating margins are often high and maintenance capital expenditure is low.

Greater opportunity to diversifyThe need for new infrastructure in both developed and developing economies means that there will be a broad and growing range of infrastructure investment opportunities listed on stock exchanges around the world.

One of the key themes that will drive growth in global listed infrastructure is the energy renaissance in North America. This is where an entirely new network of pipelines and other infrastructure needs to be built in order to access and transport the vast amount of shale gas, oil and natural gas liquid reserves in the US and Canada. This is in addition to the significant amount of investment required in building infrastructure in developing countries for the first time, as well as replacing ageing infrastructure in developed countries.

Investing in infrastructure is easier than everWith interest rates likely to remain low over the next few years, the demand for global listed infrastructure is expected to remain high. This is because investors are likely to continue to favour defensive securities that can offer relatively high dividend yield, inflation protection as well as the potential for capital growth.

Until recently, infrastructure investment was only available to large institutional investors due to the significant amount of capital needed to make an investment. Today, however, investors can invest in infrastructure through a number of managed funds and direct investment options making it more accessible to investors.

The case for investing Listed Infrastructure

0%0% 5% 10% 15% 20% 25% 30%

2%

4%

6%

8%

10%

12%

14%

16%

Retu

rn

Risks

GlobalEquities

Hedge Fund

Global HighYield Bond

Global ListedInfrastructure


Global listed infrastructure has been attracting growing attention among investors. When compared to other asset class returns in difficult markets, infrastructure returns demonstrate the potential for both regular frequent returns and lower volatility. Investors are increasingly seeking to benefit from the expected long-term global growth in infrastructure and the return potential associated with infrastructure assets. Global listed infrastructure has a set of characteristics that make it an attractive asset class:

> Value as a diversifier given its low relative volatility with global equities and historical risk and return profile

> Cash flow and income generated by infrastructure assets are relatively stable, even during volatile market conditions.

What is it?Infrastructure includes assets such as toll roads, water, gas and electric utilities, airports, as well as pipelines for oil and gas transportation. These assets are all essential to the quality of life that people experience around the world. Infrastructure assets are characterised by high barriers to entry, high margins and are long term assets lasting many decades.

Infrastructure assets also often have their profits guaranteed by long term contracts or regulation. This means that some infrastructure companies have stable cash flows and are able to pay out large and growing dividends to their shareholders. The need for new infrastructure in both the developed and developing economies means that infrastructure assets offer an extremely attractive combination of growth and relatively secure dividends – an attractive proposition in any market environment. This makes them attractive to private investors.

Stable returnsThe reason infrastructure returns tend to follow predictable and more stable paths comes down to cash flow generation and the basic nature of infrastructure assets. The financial profile of infrastructure assets is attractive as the operators of such assets usually enjoy the security of long term concessions, contracts or regulation. These long term agreements provide extremely good visibility for revenues, cash flows and ultimately, dividends.

They often include guaranteed returns which allow revenue to move in line with inflation. Some agreements also allow the company to pass through any commodity expense and interest costs incurred on the debt the company holds. These clauses insulate the company, and therefore the shareholders, from uncertainties like commodity price volatility, interest rate increases or inflation.

High operating margin and low maintenance capital expenditures close the circle, contributing to the potential for a strong and stable cash flow generation throughout the life of the assets. This enables some operators to adopt a shareholder friendly capital allocation policy in the form of high and growing dividend payments.

Outperforming Historic dividend yield of global listed infrastructure

Source: AMP Capital, Bloomberg, MSCI World, Barclays Global Aggregate Index. Total return, net

of fees, unhedged in USD. From July 2010 through 31 December 2012). Past performance is not a

reliable indicator of future performance.

Since 2003, the asset class has outperformed both equities and bonds by 7.3% and 7.6% respectively on an annual basis. Over the same time frame listed infrastructure companies have also shown a lower correlation to REITS (84%) and global equities than traditionally bonds (87).1 Listed infrastructure companies have delivered a risk adjusted return Sharpe ratio of 0.80 which is higher than the 0.59 Sharpe ratio of global bonds1.

The outlook for listed infrastructureListed Infrastructure

Yiel

d

0%2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

1%

2%

3%

4%

5%

6%

Global listed infrastructure Global equities Global bonds


Growth opportunitiesWith interest rates expected to remain low over the next few years, we expect infrastructure to perform strongly, as investors are likely to continue to favour defensive securities that have the potential to offer a high and stable dividend yield, inflation protection as well as have exposure to growth.

One of the key themes that will drive infrastructure is the energy renaissance in North America. This is where an entirely new network of pipelines and other infrastructure needs to be built in order to access and transport the vast amount of shale gas, oil and natural gas liquid reserves in the US and Canada. This is in addition to the significant amount of investment required in building infrastructure in developing countries for the first time, as well as replacing ageing infrastructure in developed countries. While governments are focused on growth and providing stimulus through infrastructure spending, high debt levels and budget constraints mean that the private sector will need to play an important role in ensuring that these billion dollar projects can be completed.

Reducing risksIn our opinion, the biggest risk when investing in infrastructure is the stability of the political and/or regulatory systems that often determine the allowable returns for the infrastructure assets. As these assets are politically sensitive and play a key role in the functioning of society, there is always a risk of a change in regulation or policy that adversely affects the returns earned on these assets. In terms of political risk, it can come in many forms – the risk of re-nationalisation of companies by countries such as Bolivia or Argentina, or the risk incurred when a new government is voted in, as with France. In terms of managing this risk, we use independent providers to help us with assessing the political risk of a particular country and

don’t invest in countries where we feel the political risk is too high or we can’t get confidence in the stability of the political system.

Infrastructure’s potential stability of cash flows supports a reliable (and often growing over time) bond-like remuneration, which can serve as protection during market volatility and a base for a steady long term total return. While the link between revenue, economic activity and inflation provides investors with the ‘optionality’ for potential equity-like price appreciation. This proven stability of cash flow throughout the economic cycle, combined with protection against inflation and generous dividend policy amid falling yields, is a key factor behind the strong performance of listed infrastructure equities in the last decade, both in absolute and relative terms.

Tim Humphreys Global Head of Listed Infrastructure

1 Source: AMP Capital, 10 years to 30 June 2013.


Over the past three years, global listed property has provided investors with strong returns. In the current low growth environment, global property securities are uniquely placed to offer investors a good source of stable income and the potential for capital growth. In addition, the liquidity of the asset class (which refers to the ease with which investments can be bought and sold in the market place) enables investment managers to respond quickly to market conditions, thereby taking advantage of the best investment opportunities.

The potential for capital growthThere are two main drivers behind the strong performance of global listed property in recent years. Firstly, Real Estate Investment Trusts (REITs) have generally invested in the highest quality real estate in their local market. Their ability to acquire the best assets has been driven by access to the cheapest cost of capital. Secondly, borrowing costs for these high quality companies have reduced. This, in turn, is supportive of future earnings growth. Higher earnings translate into higher profits and a higher share price. We believe global listed property will continue its strong performance as the case for investing in this asset class is now even more compelling than it was three years ago when the strong performance began.

While global listed property offers the opportunity for further capital growth, the asset class is also well placed in a relatively more defensive environment. It offers fundamental characteristics that are becoming increasingly important in today’s investment environment – income and inflation protection.

Higher income than government bondsBefore the Global Financial Crisis, many REITs borrowed excessively to acquire properties and expanded into non-traditional activities such as property development and funds management. More recently, however, these trusts have returned to their core business, focusing on property ownership and rental income. As such, many trusts are in a much stronger financial position today as they concentrate on clearly defined sectors of the market which generate reliable income streams.

The chart below illustrates the excess yield currently offered by global listed property trusts relative to the yield of the local 10 year government bond. It highlights that the current yields on offer are significantly higher than their long-term averages. Australian listed property trusts are currently delivering the strongest yield at almost 6%, followed by Singapore and Europe.

A natural hedge against inflationProperty is one of the few asset classes that offer investors a hedge against inflation for both income and capital. The income streams derived from the majority of commercial properties are index-linked to inflation on an annual basis. Therefore, the levels of income received, and subsequently paid out to shareholders, should reflect any increase in inflation. The capital value of an asset is also likely to rise in line with inflation. This reduces the risk that investment returns will be eroded in inflationary periods.

Greater liquidity than investing in direct property aloneGlobal listed property offers high liquidity, and prices can fluctuate on a daily basis. This, along with the large and deep property markets, enables investment managers to capitalise on opportunities more quickly and efficiently than those in the unlisted property sector. This provides investors with a simple way to access quality real estate assets with comparatively lower transaction costs than direct markets.

An easy way to access a diversified property portfolioA key benefit of investing in listed property is that it provides access to investment opportunities that may otherwise require a large capital outlay and significant acquisition costs if purchased directly. By investing in a portfolio of listed property trusts, investors are also able to withdraw small amounts of capital if needed, and have access to a range of different types of property.

The case for investingListed Property


“The surprise asset class of the next decade could yet be property which became something of a dirty word after 2007. Rental yields are 6% or so in the main markets, an attractive income stream when European corporate bonds yield just 4%. Property yields will benefit if developed markets recover; and it is usually a hedge against inflation”.The Economist 26 January 2013.

There are seven reasons why global listed real estate should be in an investor’s portfolio.

1 - Yield spread over corporate bonds One of the simplest ways to look at the value of real estate is to determine whether an investor is receiving a large enough premium over and above the risk free rate to compensate for the risks involved in real estate investment.

Historically, analysing the spread between the risk free rate and property dividend yields has been a relatively effective way to establish the risk premium in the real estate sector. As shown in the graph below, this simple analysis indicates there is an elevated risk premium in the global sector.

Dividend Yield spread to local 10 Year Bond Yields - March 2013

Source: UBS, AMP Capital as at April 2013.

However, it is important to point out that the expansionary monetary policies of central banks around the globe are artificially reducing the risk free rate. Therefore, we believe a more appropriate measure is the spread of property yields to corporate bonds. Currently, the spreads between property yields and corporate bonds, such as BBB+ bonds, has never been wider.

2 - Earnings growthIn a low growth environment, it is important to identify those companies that will see their earnings grow in excess of the average real estate participant. In a global portfolio there are multiple real estate markets in which to allocate funds. Despite an uncertain macro-economic environment a number of real estate markets offer investors double digit earnings growth.

Higher earnings translate into higher profits and a higher share price. In addition, the tax efficient structure of real estate investment trusts means that higher profits should translate into higher dividends paid, which increases the total shareholder return.

3 - Lower debt costsIt is clear that high quality companies are able to access the debt markets at cheaper rates. In October 2012 Nestle issued a bond with a coupon of 0.75% to set the record for the lowest coupon offered on a four year bond in Europe. In May 2013, the world’s largest listed company, Apple, issued three year debt at a coupon of 0.5% and five year money at 1.0%. Whilst these rates are not lower than the sovereign country in which they are headquartered, the margins are at historic lows.

The real estate sector is no different and the sector’s earnings profile continues to be enhanced by lower debt costs. In December 2012, Simon Property Group (SPG) issued $750m of five year debt at 1.5% and $500m of 10 year debt at 2.75%. SPG’s cost of debt was issued at a historically low margin to the US Treasury bonds of the equivalent time period.

We are now seeing SPG’s ‘debt experience’ being replicated in many property companies. Whether they are located in London, Paris, Hong Kong or Sydney it is clear that banks want to lend to high quality companies with strong balance sheets.

It is important to point out that whilst a lower cost of debt is beneficial to real estate companies, it is not ‘organic’ earnings growth i.e. created by the expertise of management teams. The strength of a company will dictate whether it can borrow money at a cheaper rate than a competitor. However, we do not see the benefit of lower debt costs as sustainable over the long-term.

10 year Bond

Australia Euro SREITs UK US JREITsHKREITs

Yield spread

0%

2%

4%

6%

Seven Keys to Investing in Listed Real EstateListed Real Estate


However, should interest rates rise and the cost of borrowing increase this is likely to occur at a time of increased economic strength and then real estate companies should be able to pass on this increased cost to tenants in the form of increased rents.

4 - ValueWhichever real estate market we analyse it is possible to see companies that are both undervalued and overvalued. The two key ingredients to making the right decision are:

1 - A track record of successful investing

2 - A disciplined investment process.

Like successful investors, a number of companies have been able to demonstrate long-term track records of adding value to their portfolio. For instance, Westfield’s experienced management team has successfully traded and developed the right properties at the right time.

A company that can consistently create value for its shareholders deserves to trade at a premium to its underlying asset base.

5 - JapanIt is impossible to ignore the effects of the Japanese economic policies and the impact they will have on the real estate sector, not only in Japan but globally. The intended result of ‘Abenomics’ (the ‘three arrows’ of monetary easing, fiscal stimulus and private investment growth) is to achieve a 2% inflation target and economic growth. What differentiates the action taken by the Bank of Japan (BoJ) to those taken by other central banks is the scale of the policies, no other central bank has pledged to double the monetary base in two years.

Whatever the outcome of the BoJ’s policies, the outlook for both the Japanese and the global real estate sector is likely to be positive. Success for the BoJ will result in economic growth which leads to businesses growing and an increasing demand from tenants in all sectors of the property market.

With increasing demand from occupiers comes rental growth. In addition, if the inflation target is met the index linked income streams will rise along with inflation. This will also lead to increases in the capital values of the assets. Therefore, real estate investors are likely to be hedged from the effects of inflation.

If the BoJ is unsuccessful, the monetary expansion through the acquisition of Japanese Government Bonds (JGBs) is likely to lead to a lower cost of debt for corporates. A lower cost of debt allows for a greater level of earnings to flow through to shareholders. Also in this scenario, low economic growth would make listed real estate a good alternative to JGBs for enhancing the yield within a portfolio without necessarily increasing the level of risk.

Other central banks, such as the US Federal Reserve or the Bank of England, are not adopting such aggressive policies. However, they are still engaged in expansionary monetary policy but over a longer time period. Therefore, it seems logical to expect the same effects which may take place in Japan, over a shorter time scale, will also take place in the US and UK over a longer period. It can be argued that these policies may underpin the pricing of real estate in these markets.

6 - Inflation protectionAlmost every economic textbook states that when the supply of money increases so does inflation and it appears that the western economies are trying to inflate their way out of high debt levels. The same economic textbooks detail how to hedge investments against inflation with ‘real assets’ such as real estate.

Real estate is one of the few asset classes that offer investors a hedge against inflation for both the income and capital. The income streams derived from the majority of commercial properties are index-linked to inflation on an annual basis. Therefore, the levels of income received and subsequently paid out to shareholders should reflect any increase inflation. The capital value of an asset is also likely to rise in line with inflation.

7 - Consistent yieldOver the past 10 years, global real estate securities have delivered a 9.6% annualised total return, outperforming global equities and global bonds1.

In addition, a global listed real estate portfolio offers investors a distribution yield of around 4% with forecast earnings growth of more than 6% at present2.

Tom Walker Deputy Head of Global Listed Real Estate

1 UBS Research2 AMP Capital


Listed real estate was the most popular equity sector for institutional investors in the first quarter. This insight article reveals why.The most popular equity sector for institutional investors in the first quarter of this year was listed real estate. The latest AMP Capital Institutional Investor Report, compiled by Institutional Investor magazine, found almost a quarter (24%) of respondents increased their allocation to this asset class.

There are several reasons why listed real estate was the most popular equity investment.

One is that as investors around the globe return to, or increase their investments in equities, they are seeking sectors that offer the benefits of the rise in equities but without the volatility that has been associated with them over the past few years.

Real assets real returnsInvestors seek equities that offer consistent yield, are less volatile, yet still have opportunities for capital growth.

Real estate is one such sector. It invests in companies that invest in real assets - real buildings, shops, offices, warehouses, apartments and houses.

Another reason is that real estate can provide consistent returns. The yields from rents are consistent and add to capital gains from any rises in the value of a building – as well as rises in share prices. Global listed real estate has been one of the better returning asset classes over the past decade, delivering a 9.6% a year total return, outperforming both global equities and global bonds.

It delivered these higher returns with only marginally higher levels of volatility compared with equities. In addition it provides diversification benefits, since 1991 correlation with equities and bonds are 0.64 and 0.13 respectively, making it an essential component of a well-diversified investment strategy (UBS).

Is this performance sustainable?The strong performance of the global real estate investment trust (REIT) sector is sustainable due to several reasons.

Demand - there is global demand for both yield and real assets. Liquidity is also important, given the need to live off investments post retirement. REITs are a logical investment to match ageing population demands requiring higher levels of income, lower volatility, higher transparency and liquidity.

Diversification of supply - in both existing listed real estate markets and new frontier markets we expect to see more property securitised. Over the past 18 years REITs have grown rapidly, from just four countries in 1994 to 22 countries in 2011, but still only below 10% of real property assets are listed on the public markets (UBS). REIT legislation is in place in a further 12 countries but yet to be actioned, so expect to see more opportunities, more markets and more diversity driving the market higher.

Inflation hedge - an increase of inflation will occur if there is political abandonment of austerity measures in favour of pump-priming the economies through the continued printing of money. This would lead to an outbreak of inflation. Due to the fact that REITs have real assets that are often linked to inflation on both the balance sheet and cash flow, REITs can offer an inflation hedge.

The best use of low interest ratesOne of the best ways to tap into low global interest rates is to generate investment returns through logical but cautious spread investing. In December 2012, Simon Property Group issued $750m of five year debt at 1.5%, and can invest into a European development pipeline via its investment in Klepierre delivering 7.4% yield on cost.

There is an early trend building where well capitalised market leaders within the US deploy their low cost of capital advantage into Europe and Latin America, improving management, strategy and expertise, at an opportune early stage in the real estate cycle. As an example we have seen this happen with Simon Property Group in 2012 investing in the French listed Klepiere and we are already seeing positive performance results.

The outlook for Listed Real EstateListed Real Estate


Which sectors where?We favour the highest quality real estate companies in prime markets, such as London, Paris, New York and Tokyo, taking the view that prime real estate will outperform secondary through a real estate cycle.

Japan - We like the Abenomics Japanese reflation story and the many positive implications for all sectors within the Japanese real estate market. We believe this will include growth in the rents payable by tenants through inflation linked leases and an improving economy. In addition asset values are expected to grow as inflationary conditions return and yields compress, as the returns on risk free alternatives in Japanese government bonds yields get bid lower.

Europe - We see value in pockets of Europe, but in selective markets, such as West end London office, European malls and some deep contrarian value in continental offices.

Australia - We like Australia given its attractive current yield of 5.4% in FY14 (AMP Capital, 31 May 2013), which is:

> Sustainable - it is supported by a sector wide earnings payout ratio of circa 80%, backed by contractual leases

> Growing – it is common for Australian leases to include inflation linked annual increases in rent (c4%+ annual increases). We also see the Australian real estate market as a proxy for Asian growth and underpinned by quality companies, with >75% (by market cap) achieving a credit rating of BBB+ or better.

North America - In the US, the economic recovery is strong and we believe the consumer and housing recovery has further to go. Besides the strongest companies in the strongest markets such as Simon and Boston Properties, we have exposure to the many derivatives of a continued residential recovery through multi-family and aged care residential properties.

Latin America – Countries like Mexico are rapidly transitioning as dynamic real estate markets with strong risk adjusted returns following newly created REIT legislation. In fact, they have some of the strongest risk adjusted returns of any market today.

Asia – We have become more constructive on parts of the China real estate market and see substantial value in tier one cities, in both prime, rent generating assets and mixed use development pipelines that are in the process of construction.

James Maydew Deputy Head of Listed Real Estate


The definition of real estate is being stretched in the US with recent real estate investment trust (REIT) conversion activity. While there is no concern for the future of ‘traditional’ REITs, the outlook for increased conversion activity by non-traditional real estate companies may be very different.

What really is real estate? This is the critical question that has been at the forefront of recent US tax policy debate.

We at AMP Capital define real estate as “property consisting of land or improvements to the land which include buildings or other permanent structures.” This definition can be broadly interpreted and as dedicated real estate investors, an open-mind is essential when underwriting a new property type. While a new industry entrant may appear to be atypical today, the same asset class could turn into a blue-chip sector tomorrow. Real estate in the US will always be viewed through the lens of the four core sectors of office, retail, industrial and apartments. But other non-traditional asset classes such as healthcare, student housing, self-storage, lodging and data centres have largely gained widespread acceptance from institutional investors over the past decade.

The evolution of US REITsThe US REIT structure is an efficient vehicle for owning real estate and has been emulated by nearly 30 countries globally such as Mexico, China and Australia. The structure was created by US Congress in 1960 and was designed to give the individual investor access to institutional quality real estate assets.

The REITs that employ internal management structures, high quality management teams, shareholder friendly corporate governance practices, low-leverage balance sheet strategies and investment programs geared towards high quality assets have been thoroughly rewarded over the last 15+ years with a very competitive cost of capital and strong equity share prices1.

The success of REITs over numerous property cycles has inevitably caught the attention of the executives of selected non-traditional real estate companies who are looking to reduce their company’s tax bill and boost their equity multiple via a REIT conversion. In certain circumstances, conversion offers the benefits of a lower cost of capital, lack of corporate income taxes and a more stable REIT-dedicated investor base.

Over the past two years, companies that own mobile/cell phone towers, prisons, casinos, billboards, data storage facilities, waste management facilities, automobile auction sites and solar panels have announced the pursuit of a strategy that would see a conversion from a corporation into a REIT.

The risk to the established REIT industry in the current fiscal environment is that any abuse of the REIT structure by non-traditional real estate companies could jeopardise it for the traditional REITs.

Legislation changesLegislation changes in the Canadian REIT sector highlights what could occur in the US. In 2006, a growing US$225 billion Canadian Income Trust industry was devastated by broad tax reform2.

Similar to US REIT legislation, Canada had adopted an income trust structure that allowed for no taxation at the corporate level as long as a minimum percentage of taxable income was distributed to shareholders. While Canadian real estate companies benefited from this ‘tax exempt’ status, the structure was abused by oil and gas royalty trusts, pipeline trusts and other non-real estate business trusts looking to pay no corporate income taxes. This led to a sweeping change in legislation in October 2006 that taxed all income trusts as corporations with one exception: the Canadian REITs.

Canada’s Minister of Finance recognised that the income trust structure was still appropriate for REITs and the $25 billion Canadian REIT industry was largely spared significant reform while the tax structure for the $200 billion non-REIT income trust sector was reformed to provide the Canadian government with a $500mm net tax increase as these income trusts were taxed as corporations.

In differentiating between the REITs and other income trusts, the Canadian government recognised the efficiency and wide-scale adoption of the REIT structure and did not want to put the REIT industry at a competitive disadvantage in the global real estate market.

Ensure Real Estate is in your REITsListed Real Estate


The US REIT environmentThe growing number of non-traditional real estate companies seeking an affirmative Private Letter Ruling (PLR) from the US Internal Revenue Service (IRS) has started to gain mainstream media attention. The PLR indicates that the IRS effectively approves the REIT status election before the company actually completes the conversion process. The PLR validates a company’s assets as ‘real estate’ and is the holy grail of REIT conversion as it provides a company with ‘audit insurance’. Without the PLR, no management team would risk the audit process, potential fines and tax penalties associated with a negative ruling.

Today, with the US government on unsteady, although improving, financial footing, any process that can be interpreted as tax avoidance by large corporations is going to raise eyebrows on Capitol Hill. In June 2013, the IRS slowed down the conversion process by forming a working group to review their definition of real estate, which will temporarily halt the issuance of PLRs for new hopeful industry entrants.

At the same time, widespread tax reform has been on the agenda for both the Democrats and Republicans since President Obama’s re-election and the current REIT legislation will be a topic of discussion in any large scale tax debate. The tail risk associated with this is that REITs could be at risk of losing their tax-exempt status.

While the recent wave of non-traditional REIT conversions may cause an increase in media headlines regarding the REIT industry’s tax exempt status, the traditional US REIT industry is on safe footing today and is expected to maintain this solid ground for a number of reasons:

> Any changes to current REIT legislation or to the definition of real estate used by the IRS have to come from Congress, not the IRS. Republicans and

> Democrats do not agree on the goals or scope of broad tax reform so the chances are very low that any tax reform bills are passed in the near future

> Any output from the IRS working group that better clarifies Congress’s current definition of real estate should have little impact on the core property sectors in the industry’s current investable universe given that the IRS has already issued positive PLR’s for all existing REITs

> The revocation of the REIT industry’s tax exempt status would not result in meaningful new tax revenue to the US Treasury even if REIT status was revoked for the industry. REITs are required to pay out at least 90% of their taxable income in dividends that are already taxed at the individual marginal tax rate which is roughly equal to the US corporate tax rate

> As was stressed by Canadian Minister of Finance, the REIT structure is now widely used globally, so the revocation of the US REIT’s tax exempt status would put US REITs at a severe competitive disadvantage globally

> The original goal of the REIT legislation was to provide an individual investor with access to an institutional asset class. This has not changed and the benefits of owning REITs in a diversified portfolio are even more apparent today than they were in 1960 when the original law was written.

In summary, we expect that there will continue to be debate over what qualifies as a real estate company for purposes of conversion to the REIT structure.

As we can learn from what recently transpired in Canada, the abuse of this structure can lead to a change in tax legislation and the potential for this change could lead to negative headlines for the listed real estate industry.

We have confidence that all parties recognise the attractive structure that was established with the REIT legislation of 1960 and the US REIT industry will continue to grow as investors recognise the important diversification benefits that REITs can bring to an investment portfolio.

Bob Thomas US Property Portfolio Manager

1 Green Street Advisors Inc. April 2013.2 RBC November 2006, Ernst & Young, National Post November 2007.


Global Listed Real Estate (GLRE) has provided investors with strong returns over the past few years. Can they continue to do so this year?

What is the outlook for global listed real estate?Over the past three years, GLRE has provided good returns for their investors. Last year alone they outperformed the global equities market by over 10%. (Bloomberg, May 2013).

We believe global listed property will continue this strong performance and their returns to investors as the valuation case regarding property securities is now even more compelling than it was three years ago.

There are two main fundamentals behind the strong performance of GLRE since the economic crisis. Firstly, REITs tend to have invested in the highest quality real estate in the market in which they are located in. They have tended to acquire the best assets as they have had access to the cheapest cost of capital – the share market. Secondly, their debt has been reduced. This means that they are now stronger than they were before and are now in much better financial shape.

This is highlighted by the bond-yield spread, the differential between the yield that you get from property securities and the 10 year US bond, which is greater today than it was three years ago when the outperformance really started.

In addition, future earnings growth from the listed properties securities is also greater today than it was three years ago.

Accordingly, it can be reasoned that the combination of these two metrics highlights that the performance outlook for property, in comparison to other asset classes, looks to be stronger today than it was when the outperformance began.

What are the most promising sectors and regions?There tends to be pockets within different regions and sectors which are showing extraordinary strength. However, at the same time, there also tends to be some pockets of weakness as well. As a result, it becomes very difficult to identify one region or sector as a whole which are presenting opportunities. This is especially being seen in Europe, the US and Asia.

Currently, Asia is an area which is showing to have the most compelling returns on a seven to ten year basis.

Another area of interest is the United Kingdom, where there are pockets of real estate which are performing well. This includes the west end of London and some technology- exposed, office

landlords. Both of these areas look set to do well.

The market in Australia is another area which has performed well. This has been seen in terms of retail landlords (such as Westfield) who have performed above expectations and have generated very positive returns. This outperformance may start to abate in the coming period.

The retail property sector globally was one of the top two performing sectors last year – despite the trend to online retail seemingly suggesting the opposite.

Another area which currently seems to be picking up is hotels. This is a result of business travel starting to pick up again after the economic crisis. We have seen improvements in the metrics on air and train travel and this means more time is being spent in hotels.

Industrial real estate is also beginning to look attractive but again it is worth highlighting that we are targeting the pockets of strength for our investments.

The benefits of investing in listed real estateStable, reliable income streams - To help reduce risk in a property portfolio it should be ideally comprised of properties with good tenant diversification and staggered lease maturities.

Inflation hedging - Some real estate leases contain provisions for rental increases to be indexed to inflation, while in other cases there is an opportunity to increase rental rates whenever a lease term expires and the tenant is renewed. Either way, real estate income should keep pace with inflation, helping to maintain real returns.

Diversification - Investing in property can provide important portfolio diversification benefits as different types of property have different risk and return characteristics.

Listed property has the potential for higher returns and is more liquid than direct property. While it has a higher correlation to equities, it provides diversification by investing in a wide variety of property sectors and geographies.

Global investment opportunities - From a global perspective, as more countries introduce real estate investment trust (REIT) structures, there are even greater opportunities for global investment and portfolio diversification. Since 1990 new entrants to the market have included the UK, Germany, Singapore, Canada, Malaysia and Japan and countries currently under consideration include emerging markets Brazil, China and India.

You can also view Matthew Hoult at – www.ampcapital.com/tv

Matthew Hoult Head of Global Listed Real Estate

Can global listed Real Estate continue its strong performance?Listed Real Estate

Important notice to all investors:

This document has been prepared by AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) (“AMP Capital”) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) (“AMPCFM”) for providing general information about the product referred to in this document (“Fund”) and is qualified in its entirety by any product disclosure statement, information memorandum, private placement memorandum or other disclosure or offer document and legal documentation that may be subsequently available. This document is not intended to be and does not constitute a recommendation, offer, solicitation or invitation to subscribe regarding the Fund, and is not intended for distribution or use, in any jurisdiction where it would be contrary to applicable laws, regulations or directives. Prospective investors should make their own inquiries and consult their own professional advisers as to the applicable laws, regulations and directives (including any requisite governmental or other consents and any other prescribed formalities) in any particular jurisdiction (including, in which the person comes into possession of this document) and the consequences arising from a contravention of them at any relevant time. Any failure to comply with such restrictions may constitute a violation of applicable securities law. While every care has been taken in preparing this document, except as required by law, none of AMP Capital or AMPCFM or their associates makes any representation or warranty as to the accuracy or completeness of any statement, including, without limitation, any forecasts, or takes any responsibility for any loss or damage suffered as a result of any omission, inadequacy or inaccuracy.

This document does not purport to be complete, does not necessarily contain all information which a prospective investor would consider material, and has been prepared without taking account of any particular person’s objectives, financial situation or needs. Accordingly, the information in this document should not form the basis of any investment decision. A person should, before making any investment decision, consider the appropriateness of the information, and seek professional advice, having regard to the person’s objectives, financial situation and needs. Past performance is not a reliable indicator of future performance and there can be no assurance that the Fund will achieve its objective or its target returns or that investors will receive a return from their capital. This document is provided to you strictly on a confidential basis and the information contained in it must be kept strictly confidential (with the exception of providing it to your professional advisors who are also contractually and/or professionally bound to keep it confidential) and may not be reproduced or redistributed (in whole or in part) or otherwise made available to any other person in any format without the express written consent of AMP Capital or AMPCFM. All information contained in this document, unless otherwise specified, is current at the date of publication and will not be updated or otherwise revised to reflect information that subsequently becomes available, or circumstances existing or changes occurring after that date. By accepting a copy of this document, you agree to be bound by the limitations, terms and conditions set out in this notice.

Contact usIf you would like to know more about how AMP Capital can help you, please visit ampcapital.com For your local contact, please visit ampcapital.com/contact or email [email protected]

AMP Capital Listed Real Assets Investment Insights 2013 · experience, understanding, networks and...

Documents

Transcript of AMP Capital Listed Real Assets Investment Insights 2013 · experience, understanding, networks and...