Higher interest rates priced into real estate stocks

The continual rise in interest rates since the start of the year is weighing on real estate stocks. The European Central Bank’s rate decision at the start of June pushed listed real estate stocks down once again. Globally speaking, the asset class has returned a modest 2% in the year to date. Asia’s strong gain of 20% has been offset by the negative performance of the UK market (- 14%) and sideways trends in other regions.

Of course, there are positive and negative sides to any market movement, according to UBS Investors’ Guide dated June 22, 2007.

UBS analysts continue to take a positive view of listed real estate stocks. Given the sharp rise in rates at the long end since January (+9% in the US, +16% in the UK, +18% in Euroland, and +6% in Australia), the range trading in global real estate stocks reflects the sound health of the underlying unlisted market.

Just like bonds, investments in real estate react badly to rising interest rates, but not when income can be increased by reducing vacancy rates, increasing rents or expanding the development and fund under management businesses. This is exactly what is happening at present.

 

Reduced expectations

In UBS analysts’ view, the new interest rate environment has already been priced into listed real estate stocks, and expectations regarding long-term earnings growth are not unrealistically high. Based on UBS economists’ rate forecasts, UBS analysts were previously anticipating a total return of about 15% for the sector in 2007. This performance forecast needs to be reduced now that the prognosis for long-term rates has been revised upward. A total return of 5-10% for the year as a whole seems likely. Asia, including Japan, is the favorite region. “We believe that companies active in real estate development offer better return potential than pure investment players. These companies are profiting most of all from rising demand and tight supply on most real estate markets and from strong demand for investment properties,” concludes the UBS report.