An update of the European listed real estate sector: valuations, focus on interest rates, outlook

1. 26 February 2018
Update: listed European real estate strategies
By Olivier Hertoghe, Damien Marichal & Vincent Bruyère
Senior Portfolio Managers, Degroof Petercam AM
The de-rating of the retail sub-sector continues, based on persistent fears of lower growth in rents and
values in the medium term. The main companies we like from a fundamental point of view have reported
solid operational performances and are pointing towards a continuation of this trend. Some of these
companies in the screening have exhibited attrative multiples and dividend yields, for instance Unibail-
Rodamco having a dividend yield of 5.6% which is to be paid soon.
Volatile interest rates
Volatility of interest rates and credit spreads have hurt the listed real estate sector based on the commonly
accepted view that it is a bond proxy. This is particularly true for the German residential sector, which has
suffered more on the back of this. These two (retail and German residential) large sub-sectors are
responsible for the largest part of the correction we have seen year to date 2018.
Please note that we have seen correlations with interest rates shooting up before, as the graph below
shows, but that we believe that listed real estate is not highly correlated to interest rates.
Source: Degroof Petercam AM Quant Team, 05 February 2018
Direct property: the main driver
The main driver remains direct property markets. This is the fundamentally correct parameter to assess the
listed property sector.
By now this direct property market has not shown any sign of weakness. Of course, we cannot ignore that
the real estate cycle bas been up for several years now, and that most value growth coming from yield shift
is now behind us.

2. 26 February 2018
Meanwhile, risk premiums remain high, as companies are still developing or buying at yields significantly
above cost of financing, and rental growth should further support the market. The ultimate question is
whether higher interest rates will affect the direct property market. At the interest rate levels we see
today, we do not believe this will be the case.
Higher interest rates = not a disaster
Furthermore, higher interest rates are due to higher growth expectations and inflation expectations, which
both are positive for real estate as it increases consumer confidence/spending and demand for offices. This
results in higher rents stemming from increased demand and indexation of lease agreements.
Looking ahead
Degroof Petercam AM’s base case for the next twelve months is that – at constant discounts to Net Asset
Value (NAV), currently standing at approximately 14% – a total shareholder return of +/- 8% can be
expected, based on a 4% dividend yield and 2018 NAV growth of 4%.
For the sake of clarity, this is a base case scenario and the actual 12-month performance will depend on the
view of investors on this discount of 14%:
• If they believe it’s too wide for the good prospects of the direct market, they will be prepared to
pay more and reduce the discount, which should lift performance above 8%.
• If fears of a deteriorating direct market increase, investors will expect decreasing NAVs and may
demand higher discounts to last reported NAVs. This would decrease the 8% base performance
expectation.
We are of the opinion that a 14% discount already reflects quite a lot of potential risks, and that current
levels might well prove to be an interesting entry point for the longer term.
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