After several years of being bullish on United States equities, this column last year downgraded that view in favour of European equities. But value can still be found in other US asset classes, particularly property, as a long US housing cycle continues to recover.
The divergence between Australian and US property are striking. In Australia, residential property prices in Sydney and Melbourne are at frightening levels. Everybody knows house prices have run too far, too fast, but record-low interest rates are spurring demand.
Listed property, via the Australian Real Estate Investment Trust (AREIT) market also looks fully valued after a strong rally in the past 18 months, mostly because of record-low interest rates driving investors into higher-yield securities and out of cash and fixed-income securities.
This column has had a good run identifying small- and mid-cap AREITs such as BWP Trust, Shopping Centres Australasia Property Group, National Storage REIT and Hotel Property Investments. But it is getting hard to find value in the AREIT sector.
It’s a different story in US property. Its REIT sector, although well up, has not rallied as hard as Australia’s over one and three years. And there is better value in US residential property, particularly in markets such as New York, which are undersupplied.
Moreover, the US economy, while still patchy, has more momentum than Australia’s. Our economy is slowing faster than many realise and a recession cannot be ruled out in the next two years if the commodity rout quickens and business and consumer confidence tank.
An obvious way to play the recovering US property market is through Australian trusts, such as Westfield Corporation, that have strong shopping-centre exposure in that market. But the big AREITs look fully valued. Better valuation opportunities await those prepared to look further down the market, although they come with higher risk and suit experienced investors.
The US Masters Residential Fund (URF) is an example. It was the first Australia-listed property trust established to invest directly in US residential property. It invests in undervalued neighbourhoods in growth markets that are being gentrified and typically appeal to families, and are within an hour’s commute of downtown Manhattan.
The group’s portfolio of New York metropolitan area residential housing and apartments consists of about 2,000 housing units across 534 freestanding houses and 27 apartment buildings.
Residential property REITs, well-established in the US, are an unusual concept in Australia. URF listed on ASX in July 2012 after raising $65.8 million. Its $1.62 issued shares have rallied to $2.20. URF’s latest stated net tangible asset (NTA) is $1.98 per unit.
Chart 1: US Masters Residential Property Fund
URF is not cheap. But it is a reasonable bet that its NTA will continue to rise in 2015-16 given tight residential property supply. New York does not have enough residential property at the best of times, and the 2008 GFC exacerbated that situation as new stgelopments came to a halt.
Although US construction activity is recovering, it remains well below historical averages, suggesting further residential property price gains as demand rises and supply is limited. In its latest annual report, URF says it continues to see a resurgence in the local US real estate market, with some sub-regional markets delivering double-digit growth in capital values and rents.
URF looks ideally positioned to capitalise on that trend. A well-timed float gave it enough capital, since bolstered with further raisings, to buy more US residential property and it benefited from an overvalued Australian dollar against the Greenback, and subsequent falls.
Currency risk is an important consideration. URF is exposed to US dollar currency risk through holding US dollar cash balances, investing in US-based investment property and deriving rental income from those properties. It generally does not hedge foreign-currency risk.
Further expected falls this year in the Australian dollar will be a tailwind for URF, but not nearly as strong as when our currency traded above parity with the Greenback.
There is a lot to like about URF. It provides listed exposure to residential property when nearly all AREITs focus on office, commercial, industrial or niche segments. US residential property looks better value than Australian property because of supply constraints in key markets and stronger expected demand from a recovering US economy. And a 4.5 per cent distribution yield is another attraction.
The question is whether those attributes are fully reflected in a unit price that trades well above asset backing. With so many other AREITs trading above NTA, one could argue that URF looks fair value in relative terms. A better strategy is watching and waiting for improved value in URF, and giving it a prime spot on portfolio watchlists for those seeking US property exposure.
Tony Featherstone is a former managing editor of BRW and Shares magazines. The column does not imply any stock recommendations. Readers should do further research of their own or talk to their adviser before acting on themes in this article. All prices and analysis at April 15, 2015.