Market Commentary as of 3/31/08
Real Estate Rebound
Following a poor fourth quarter in 2007, and indeed a poor year in general, North American property returns rebounded into positive territory during the first quarter of 2008. It was anything but a smooth ride, however, as economic concerns continued to mount amid speculation that the US was in the midst of a recession.
The top performing sectors for the Fund during the period were in Self-Storage and Apartments, followed by Retail (both malls and shopping centers). Public Storage, the largest owner and operator of storage space in the world, dominates the Storage sector, and led all the companies in the sector to strong returns during the quarter. The slowing economy has yet to affect the self-storage arena materially, though it likely will going forward as results tend to lag economic indicators. The apartment sector possesses something that other sectors are sorely lacking—liquidity. Government sponsored agencies Fannie Mae and Freddie Mac continue to have adequate capacity and a strong appetite to finance multi-family transactions with favorable terms. The availability of this low-cost debt has helped to keep capital rates relatively low for the group, and has facilitated large transactions.
Malls, Malls, Malls
We continue to like the relative stability of the Canadian marketplace in general, though volatility has certainly increased there as well. Overall, the Canadian economy continues to be healthier than that of the US, especially in the Western resource-driven provinces. Still, the weakness in the US economy will have a spillover effect in Canada given that the US is their dominant trading partner.
Within the US, we remain most positive on Retail, especially the mall sector, despite the negative sentiment that surrounds the group as store sales growth slows amid increasing concerns about consumer spending. As we have stated numerous times in the past, we like the long-term nature of mall leases, the lack of meaningful new supply, and the continued healthy demand for A-quality mall space from tenants. All of the mall holdings in the Fund possess “A” quality portfolios. Within the shopping center portion of Retail, we think sales should hold up relatively well even in a softening economy, as many necessity-based retailers are present in most centers. However, we have become wary of those companies with a meaningful development pipeline that are often heavily dependent on housing growth within their respective trade area.
The only other sector overweight of consequence is Apartments. In addition to the benefits of liquidity mentioned above, the sector possesses positive traits such as strong demand from that coincides with the drop in homeownership rates, favorable spreads between renting and owning, and valuations. These factors are currently outweighing the negatives the group is experiencing in the form of slowing fundamentals, supply concerns (especially in condominiums and single-family rentals), and slowing job growth.
Waiting for the Dust to Settle
The correlation between REITs and financial stocks has increased substantially during the past five years, and it has been especially high thus far in 2008. Despite this trend, REITs still compare quite favorably to financials in terms of earnings growth and leverage levels. Still, REIT returns are likely to remain quite dependent upon the overall health of the Financial sector. Uncertainty—and therefore volatility—in the property markets is likely to persist going forward until there is better visibility as to the end of the housing bust and the economic downturn. Real estate lending will first need to return to a more normal state, which may not happen until well into 2008, after banks and other lenders fully communicate the extent of any additional loan write-downs.
From a balance sheet perspective, most of the publicly traded real estate companies in which the Fund invests are in a healthy position, not having boosted leverage to unreasonable levels by chasing low cap-rate acquisitions during the past few years. Despite weakening fundamentals across the asset class, we believe the balance sheets of many of the companies the Fund owns are uniquely positioned to capitalize on more attractive pricing that is likely to present itself once the dust settles.
ABN AMRO Asset Management
Chicago, IL
Note: Real Estate funds may be subject to a higher degree of market risk because of concentration in a specific industry or geographic sector. Risks include declines in the value of real estate, general and economic conditions, changes in the value of the underlying property and defaults by borrowers.
The views expressed above are for informational purposes only and is not intended as investment advice. Since the date of the commentary, economic, market conditions and the portfolio manager's views may have changed.
As the fund is actively managed, the securities as presented do not represent the current or future composition of the portfolio.
Past performance does not guarantee future results. Investment return and principal value of mutual funds will vary with market conditions, so that shares, when redeemed, may be worth more or less than their original cost.