Capital Markets Coaching Clinic: Cranes and capital

The Real Estate Securities and Income Solutions (RESIS) team at Delaware Investments outlines the entirety of real estate as an asset class, discussing the historical benefits, and risks an allocation to real estate can provide to an investment portfolio.

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Capital Markets Coaching Clinic: Real Estate Investing

Erica - 00:02
Good afternoon. My name is Erica Kay and on behalf of Delaware Investments I would like to welcome you to our Capital Markets Coaching Clinic on the real estate investment climate today. Our event is a part of the Delaware Investment evolving advisor practice management program. Whether it's keeping you ahead of the curve when it comes to technology and social media trends, helping make your work day a little more efficient or learning more about the capital markets from our team of experts, we strive to be your partner in growing your business and serving your clients. Just a little house-keeping before we begin with this investment related value add event today. Feel free to submit a question via our Q&A widget below the slide window that you will see there. And we will try to get as many as we can today towards the end of our event. Also feel free to access our presentation material via our resources widget to the left of our slide window. And in order to help better serve you with this content in the future we would appreciate your feed-back via our survey widget, also below the slide window. Finally, live listeners please stay tuned for information regarding your C.E. credit following the end of our presentation today. Now we will get started. Our panel today is from our real estate securities and income solutions team. I'm going to talk to the round so everyone can introduce themselves.
First we have Chief Investment Officer, Bob Zenouzi. "Good Afternoon".
Senior Portfolio Manager, Damon Andres. 'Hello everyone'.
Senior Equity Analyst, Scott Hastings. "Good afternoon".
And Equity Analyst, Penghui Sun. "Good afternoon".
Scott I will turn it over to you to begin today.

Scott - 01:54
Thank you Erica and thank you to everyone listening . We really appreciate you taking the time to learn a little more about the real estate universe. I thought today we would start off with an introduction about REITs. As well as to dive into the development of the global REIT market and how it has evolved over time. We'll talk a little bit about performance, some of the pros and cons of the space and then maybe where we are today in the global REIT market and where we see the greatest opportunities going forward.

So with that, diving right into it, to start with the basics, what exactly is a REIT? Well a REIT is a real estate investment Trust. It's a vehicle created by Congress in the 1960's and the idea was to provide investors access to a market that they had not had access to. And that was the commercial real estate market. Traditionally commercial real estate had been invested on the private side and the advent re-structure provided investors with the ability to access it in a more liquid form. So what exactly do REITs do? Simply put REITs own real estate. Simply put REITs own real estate. They own, they buy, they develop properties. Within these properties they collect that rent, they pay off their own expenses, they pay interest expense and they pay off their income in the foreign dividend to shareholders. So the shareholder gets the benefit of a recurring income stream like you would in traditional real estate but has all the potential to appreciate, capital appreciation, over time. REITs really invest in all types of property, virtually anything you could think of can be put within a real estate tax structure. There are lots of types of properties you may think of. There is shopping malls, apartment buildings, office buildings, hotels. And there is a lot you may not traditionally think about including cell towers, data centers, prison REITs. If you think about cell towers everybody uses their iPhones or their iPads as they send a message out it has to bing off a cell tower. That cell tower is owned by a REIT, that's an income stream they earn from leasing out that space to the AT&T's and Horizons of the world. So REITs are not just about simple bricks and mortar real estate that you might think about, there is really a wide variety of real estate that this encompasses. So when you think about allocating money across lots of different investment sites the first question will always be why consider a REIT why did you even think about it. There are a lot of benefits to the space. One of the most important is the diversification factor. Historically if you look at REITs over time they have a very low correlation to stocks and bonds so really help improve a portfolio as a whole. One of the most attractive attributes to REITs is the dividend. If you look at here in the US and abroad there is slightly different structures but in general REITs are required to pay out virtually all there free cash flow in the form of dividends. So as an investor you gain access to a very favorable income stream and as the REITs are able to drive rents higher you are able to drive up your cash flow and drive up your dividends. Another benefit of REITs is not just a dividend story they are really about growth too as well. If you look back historically at REITs about 50% of the return has come in the form of dividends and 50% in capital appreciation. So as the real estate increases in value you also get capital appreciation from typically higher stock prices. One of the real beauties of the REIT structure in the public format is the liquidity. Real estate has historically been an illiquid investment so the ability to enter and exit the market as an investor sees fit is a real positive. As we get further and further down the cycle and look at today with the Fed looking at maybe raising rates at some point, you know you start to get inflation and historically REITs has offered a great hedge to inflation over time and my colleague is going to dive into that more in a minute. And I think the last important point, and this is one that really is understated, is really the growth potential of the REITs universe. Today, globally US REITs hold about 10% of real estate held in the public's hands so there is still 90% held in private hands of real estate. As that evolves over time that should grow substantially and offer really strong growth across the sector. I'm going to turn over to my colleague Damon who is going to take a minute to discuss about the development of the global REIT market today.

Damon - 06:01
Thanks Scott and thank you everybody on line for your interest in the global REIT market. Now that Scott has given a background and some information on what really is involved in the REIT structure and what makes a REIT a true real estate company. I'm going to go over a little bit of the background and history of the development and the growth in the REIT market. On the first slide you will see a geographic foot print of the timeline of the acceptance of the REIT structure across the globe. And as you can see and surprising to most investors, even surprising to us if we put it in the context of the investable universe, the REIT structure actually started in the 1960's in the United States. Over fifty years ago. However, for the first thirty five years or so it was really an illiquid and non-investable asset class and the companies represent in the market place were relatively marginal quality. It really wasn't until the mid 90's that we industry veterans call the modern era of REITs, where REITs really got a critical mass and real estate managers realized the benefits of being a public company. Namely the ability to access the capital markets and manage real estate as an ongoing concern not as just a short lived investment opportunity. So in the mid 90's given this sentiment change in the market the US realized significant growth in the real estate asset class through the late 90's. And it really wasn't until the late 90's during the .com bubble or the pop of the .com bubble that the market truly realized the benefits of the risk and return characteristics of real estate and the rest of the world really caught on. You can see into the 90's a few companies accepted the REIT structure and into the 2000's significantly more did. It was really first some EM countries and then some developed companies that followed suit on the legislation of the REIT format. And now as we stand today there are about thirty countries that have adopted the REIT format and they have created a truly global platform for real estate investing. Jumping onto the next slide, there is a lot of detail in this slide so I am not going to walk through the line item detail here. You can peruse that on your own after we are done. But the main takeaway's from this chart are the last six years of growth across the world in the real estate market. I think that the major highlights you will see is the regional representation across the globe to participating real estate in every region on the globe and that still today US, given that it was a first mover and the early success that it had, still has a majority share with just under 50% of the global index market capitalization. And then finally given that the growth that we have realized in the investible universe all the reasons, except for EM which definitely can be understood that they haven't grown as fast in the last six years, but all the other regions have at least doubled and some tripled in the last six years. Signaling the investor acceptance is listed real estate as an asset class. The next few slides are going to go through just the growth in the market capitalization in equity and debt issuance of listed real estate. On the first slide it's just the outright market capitalization represented per listed real estates. The blue as you can see represents the true REIT structure and the brown is actually real estate operation companies that are still part of the investible universe to get real estate exposure globally. And basically as you can see from this chart the market capitalization has tripled since the financial crises or has at least doubled since the prior peak. And again this just signals to us the acceptance of investors in the capital markets for real estate as an asset class. And then very important the text note at the very bottom of this chart you will see that MSCI and the S&P 500's just this year accepted real estate as a stand-alone industry classification so currently it is a subsector in financials but as of next year real estate will be its own general industry classification code, which we think will catapult real estate into the next era of evolution and growth into the market place. And to see this growth we really need acceptance from both equity and debt markets. The next slide shows the growth for equity issuance for listed real estate broken up across the three major regions across the globe. And as you can see we are approaching roughly over the last few years averaging 100,000 million plus US dollars worth of equity issuance annually. So again significant availability to capital real estate. The next slide is the same slide but for debt issuance. And because real estate is one of the more leveraged industries out there and the real estate companies utilize more leverage than other companies and other industries the participation of the debt market is critical for their growth. And clearly in this slide again you can see the growth. And to the next slide, it's the last before I hand it over to Bob. I just want to talk a little bit about the benefits of investing in real estate and the differences that we have seen. From ten years ago being just a US only dominated industry to now a truly global industry. And while the trend for investors ten years ago was to accept US REITs the trend today clearly is investors looking for global REIT footprint. And while the US still is an anchor weight in the index and, again, is roughly just under 50%, the global exposure now creates opportunity and diversification for investors. And finally it gives the investors the ability for different business models. Where US is traditionally just owner/operator have real estate, the international companies can offer development and apartment and home building expertise. And with that I will pass it over to Bob to talk about some characteristics of REIT performance.

Bob - 13:08
Thanks Damon and good afternoon. Now that Scott has given an nice introduction and Damon has built on the development of the REIT market let's talk about performance. And then some risk and other characteristics that I think are very important. When we look at performance we are looking at this slide which goes back to 1977 through about three and a half decades. I think surprising to many when I show this chart, is that REITs have outperformed most asset classes, including direct real estate. So you can see over the past three plus decades REITs have provided a 13% annualized return. When you compare that to the S&P 500 at 11.9% that's out-performance. That's a steady out-performance and the importance of this out-performance isn't just the absolute terms but just think about the really massive bull markets that we had in stock in the 1980's and the 1990's and yet real estate supposedly a high yield, low growth business out performed during that time. Not only did they out-perform the S&P 500 but it outperformed MSCI world indices, Nasdaq, EM, commodities, inflation. So it has truly been an exceptional asset class. Over the long term and what's really interesting it's out performed direct real estate. So many have invested in non-traded REITs. You would think that if you were handing your money over to an illiquid investment you would get illiquidity premium meeting out-performance but in this case it shows the efficiency of owning and operating real estate in the REIT format and REITs have outperformed direct real estate over time. So why have they out-performed? Well it's the stability of the cash flow through contracted long term leases. What that leads to is a higher than average dividend yield. Higher than stocks, very competitive or higher than fixed income today. And because these leases are indexed to inflation, meaning every year they go up at a fixed bump or CPI, whichever is greater so keep up with inflation. That has lead to dividend growth. So that is the key, it's not just the higher than average yield but the ability to grow that yield over time. And that's one of the reasons we have seen out-performance of the asset class. One of the negatives I hear about REITs is the volatility . Real estate, or REITs in this case, are marked to market so we looked at the volatility over time in this risk return chart. No doubt REITs have had great performance on an absolute basis but their volatility has been higher than stock and obviously bonds. But when you look at it on a risk adjusted basis the volatility that you are incurring really is paid for by the higher rates of return and therefore the sharp ration , or the return for unit of risk, is much higher in REITs than it is in the S&P 500's or MSCI World. And when you add REITs to a portfolio of equities, whether it's global or domestic, REITs provide higher returns and less risk. So REITs are quiet additive whether it's domestic or global REITs to a diversified portfolio. Another way to think about this risk is if you buy a piece of real estate, you buy a home or if one of your clients has bought an industrial property or maybe an apartment building they are not holding it for a quarter, they are not holding it for six months. They are holding it generally for seven, ten or fifteen years, for a very long term. Well if you think about your REIT investment the same way over time that volatility comes down. Yes it's marked to market but they are still paying a dividend yield, they are still growing the dividend and that volatility really shouldn't be an issue if you think about it as a long term real estate investment. So don't worry as much about volatility and don't think of the volatility as risk. Take advantage of it the last year when REITs were up 30% you sell something. This year they are down about 11% because of interest rate fears, you round it out and add to your position. So if you think about it as a long term investment you out-perform. And lastly, this worry about interest rates, when we look at REITs for correlations of sensitivities of rates in the short term yes they might be sensitive. Back in 2004 we remember when REITs were down 15% because of interest rate fears and then once the market understood that the economy was fine REITs went on to out-perform the S&P 500. Same thing in 2013 and the same thing today. In 2015 we are seeing interest rate fears and so it's much more perception than reality. You look at the columns on the very far left that puts NAREIT, Domestic or global index what you see is very low correlation with Barclays US Agg. or the Barclays Global Agg. It's very similar to if you bought your house and you placed a thirty year mortgage on it you don't care if rates went up because your mortgage rate is fixed. The beauty is if rates go down you can re-finance. REITs do the same thing, their leases are locked in with bumps in place. They go out and they place debt on the property and that debt is fixed so rising rates don't affect cash flow. So very little correlation with REITs over time. Then I think the really important chart here is the last slide. This is why REITs have out-performed and why they're not inter-sensitive and why they can fight through inflation is twenty three years of dividend history shows that REIT dividend have grown on a compounded annual basis of 7.2%. Inflation as represented by PPI has grown by just 2.4%. So we start off with a higher than average yield, we can grow that dividend almost three times more than what the inflation rate is. That's what has lead to out-performance in the asset class. Back to Damon to discuss benefits of REITs.

Damon - 19.04
Yes great and what I'll do... you know Bob's talk mentioned some of the great characteristics of REITs performance historically, but I'm going to focus on a couple of the topics that we see in today's market and one of the big focuses that we hear from the investors today is just getting where we are in the cycle. How will REITs perform during rising interest rates and a rising inflation period and those kind of macro events affect on REITs performance. We'll look at the first slide, the first couple of slides, as it pertains to inflation. You'll see firstly that this first slide will show you the percentage of time that different asset classes out-performed inflation during periods of high inflation. As you can see as expected the best performing one is commodities and I don't think that is to anyone's surprise. The second best however is REITs and Bob mentioned there are a lot of reasons as to why that happened but statistically this shows you that REITs are virtually as good as commodities as an inflation hedge. And to be clear though, this is just the percentage of times that REITs out performed during inflationary periods not so much the magnitude. To the right what is really interesting here is the bar called the blend, which is a blended portfolio and you can see some of the details of that blended portfolio at the bottom. But adding 30% REITs to a diversified portfolio can actually optimize the portfolios performance during inflationary periods. And Bob mentioned some of the great diversification benefits and this is just another one that REITs offer in a diversified portfolio relative to their ability to hedge during inflation. The next chart, or the next page has a couple of charts that depict the actual magnitude of performance during inflationary periods. And also the magnitude of performance during low inflationary periods. The chart to the left on this page you'll see that as expected again commodities clearly are strong performers during inflationary periods. However the chart to the right would show you one of the worst performers during low inflationary periods is commodities. So commodities you will see is highly correlated to inflation. However if you look at the light blue line which is the REITs during high inflationary periods REITs do not perform as well as commodities but they are the second best producing very strong returns. And even when inflation is low REITs still have the ability to out-perform as one of the best asset classes. This highlights the consistent and predictable nature of cash flow generation by REITs. Moving on to the next page a little bit more controversial is REIT performance during rising interest rates, not during rising inflation. A lot of investors have misperceptions about this just by the fact that rising rates and rising inflation have a high degree of correlation. Two facts I would state out, clearly REITs do get a tail wind when rates are going lower from their ability to refinance at lower rates, but again as Bob mentioned, once they refinance, their rates are set for a pretty long period of time and it is very predictable on their interest rate cross. Second is volatility, will kick in in REITs as we have seen recently this year when interest rates bottom and they do start to rise in the initial phase of that transitionary period. This second fact happens because of a basic misperception by the market place that rising rates will hurt real estate. As you can see we highlight a few points on why this is a misperception and the statistics show you why it is a misperception as well. But namely real estate is structured to the extent that the cash flow generation has built in escalators to protect against inflation. Namely they have escalators each year or the leases are set to increase with inflation and that is a pretty standard feature across the globe for real estate leases. Thirdly, depending on the type of company, leases that are shorter in duration are reset with inflation. Hotels, for example, leases are reset on a daily basis because you basically go to a hotel daily. Storage facilities reset their leases monthly and apartments reset their leases annually. All of those companies have a great ability to raise rates during an inflationary period. And then fourth I think another benefit associated with real estate cash flow to rising interest rates is the fact that rising interest rates are associated with a better economy. And when you have a better economy you get better demand for real estate. And with better demand it creates a supply demand imbalance which by default allows real estate to have pricing power and to rise rental rates. And then finally the dividend growth, which we did mention earlier but is a clear benefit, during rising interest rates and rising inflation most true real estate companies will have a great ability to raise dividends unlike a six income asset class where your coupon payments are fixed for the duration of that fixed income instrument. Real estate actually raises their dividend when cash flow increases. And then finally, I would say important, we as active managers, depending on the cycle whether we are at an inflection point of raising or lowering interest rates, we have the ability to actively manage the portfolio to seek out companies which will be best advantaged during these changing periods. By focusing on companies with more or less leverage, shorter or longer duration periods or shorter or longer leases. So we can optimize what companies we own during inflationary or noninflationary, or rising rate or lowering rate period. And then finally, one last graph to highlight that REIT performance can outperform during rising rate environment. You will see form this last chart in 2004, the last time the Fed raised rates, REIT pulled back in an initial really quick reaction about 16% in the first phase or the first worries of an interest rate hike. However after that first correction and the market absorbed it and got comfortable with the cash flow REITs outperformed the S&P 500 by 29% over the next year and 45% over the following year. And with that I will pass it over to Scott to talk about some of the risks of self investing in real estate.

Scott - 26:36
Great, thanks Damon. I hope we all understand our positioning on how we don't view rising rates as a real fear for the REIT industry, it actually should translate into very good growth. That being said what are the risks, what are some things we should watch out for as we are looking at investing in the REIT sector? And when we think about risks in the real estate sector we think about 'Cranes and Capital'. And what do we mean by that? We think about supply and we think about the capital market. Take one of these at a time. Supply, it's pretty typical I should think, about basic demand and supply economics. Typically what happens in real estate in a typical cycle is the economy is doing well, people are feeling great about their businesses, developers are getting more aggressive. They start to put up these speculative office buildings, new shopping centers and that comes at the worst possible time for the... the worst possible economic time, the economy has a hick-up and all of a sudden it all is vacant space. And so the economy has to start to recover and absorb all that vacant space. So supply obviously tends to be an issue. If you look at the last five real estate downturns four of them are supply lead, the other one being the great financial crises most recently. So supply is something you have to constantly monitor when you are looking at the space and you have to think about 'where could there be excess supply? Where are people getting too aggressive? And where there could be a risk?'. What is interesting coming out of this downturn is we haven't really had supply delivered in any meaningful way. If you think about the latest cycle it was really a housing cycle. So from the commercial real estate standpoint people really didn't take on speculative office buildings, speculative shopping centers, and the simple reason for that was that the highest and best use of land was housing. So if you were a land owner the best way to get the best economics for a piece of land was to develop housing. So that really didn't translate into excess supply into the current market. So we look at today and, largely across all the developed markets, we simply don't see a large amount of supply. Another great part of this downturn as we have been coming out of, is that development lending has been very restrictive. Banks have been more conservative with their balance sheets and are not looking to aggressively lend out to merchant developers so it has really limited the supply that has come up the markets. But as you look at risks in real estate supply is one of those that you need to monitor but today we just don't see it in most areas of the developed market. In the emerging markets, definitely there are some issues. The second issue and probably the bigger issue in general is the capital markets. Really simply put the capital markets... real estate's raw material is the capital markets. If you think about REITs balance sheet they are constantly accessing equity and debt capital if they want to grow their businesses. So when those capital markets are unavailable or get drastically more expensive it can really hurt REITs valuation. We saw this in 2007/2008. A cross example just here in the US think about from the peak in '06 to the trough in '09 real estate, their cash flows, their operating cash flows, fell by 11%. So in the worst financial crises since the great depression cash flows only fell about 11% of the operating level. Stocks fell 72%. During that period what happened was that capital went away, capital was completely unavailable to a bank to a REIT, to anybody. So when you think about the risk the real risk to real estate is the capital markets, are they available or are they shut down and what is the cost of that capital. Where we are today, the capital markets are wide open. We are awash in liquidity, whether it's in the US, in Europe, in Japan. Central banks across the globe are easing, banks are lending, so it's a great time to be borrowing money both equity and debt capital and it's really not a concern we see at all. We haven't seen any widening in spreads to cause us any concern thus far. So in general when we look at the environment today supply is just not a risk the capital markets are wide open and so the two biggest risks of real estate just simply aren't there right now. They are something we have to constantly monitor but they're not there. And the last risk would be stagflation and that's in some of the emerging markets you are seeing such as Brazil where they have higher rates and limited to no growth. And if you think about the risks of real estate it really dovetails into how we invest. We invest when you think about it, we really have to focus on two things that really adjust and really affect revaluation. One is fundamentals and two is the capital markets. The fundamentals we monitor, it's the slow moving, they lag the broader economy, but really we monitor the capital markets. The change in availability of debt and equity capital which occur daily in the public market that's really what can pressure real estate. So if you think about or process which is a dual bottom process focusing not only on the ground boots fundamentals but really looking at the capital markets and understanding how those changes in the cost capital will affect real estate pricing. That is really where we spend a disproportionate amount of our time understanding how that affects real estate lending. And when you think about it simplistically if you are going to go buy a house today if you can get a mortgage at 3.5 or 4% versus you have to get that mortgage today at 7% how much house can you afford. It is a drastically different valuation. So you should always spend so much time think about where are the credit markets and that help you avoid any pitfalls in terms of valuation. So those are the risks and where are we today in the real estate market, and thus far how have real estate stocks performed? Well coming into the year there was a concern in the US about rising rates and as Damon mentioned earlier what happens with most cycles is you get a pull back in REITs. And we have had that happen here where REITs sold off about 13% from their peak in late January to most recently. That has created a great buying opportunity and in the slide here what you are seeing is that these are premium discount NAV. How you read this chart is what the stocks are reflecting relative to private market values. So if you look at the US today, the US and the public market is trading at a 10% discount relative to private market values. That being said that is translating as saying that public REITs are 10% cheaper than what is on the private market. That is a great buying opportunity. Historically that number is about plus 3 to plus 5. So the US REITs are a great value right now today and it's a market we really like. A lot of this is driven by rate fears but as Damon outlined earlier those fears are largely unfounded over time. If you look at that conversely an area like Japan, Japan public markets are pricing at a 40% premium to private market values. That is extreme valuation, they are predicting that asset prices in Japan are going to 35%. That is huge premium, so it is an area that we are very cautious on, we don't think that's simply warranted. Those stocks have performed year to-date, but given where we see valuation and given where we see value in the US, we think US is a great value. Europe here, Europe has performed very well year to-date, it ran very hard as Draghi came out with the ECB's announcement for quantitative easing and the stocks are about 20% in the first two months. This premium valuation is a bit misleading. There are some very good opportunities particularly in the periphery of Europe, such as in Spain and Italy. And there are some more expensive areas in Europe. So we are finding some pretty good opportunities in Europe as the stocks have pulled back nicely in the last two months. So as we look at it today what we are seeing is tremendous value in the US, a great buying opportunity and still self buying unique opportunities in Europe. And still in the periphery as well some other opportunities across the globe. Truly by great companies and great assets at large discounts to underling asset dives. Now I'm going to turn it over to my colleague Penghui who is going to touch on China and some of the issues we are seeing in the emerging markets.

Penghui - 34:13
Thanks Scott. One of our main concerns today in China, China's economic growth continues to slow down despite aggressive government easing since last November. Real estate development has been one of the most important drivers for investment and for GDP growth in China. However, as you can see from the charts, property sell volumes, that is basically new home sells, peaked in 2013 and remains in a declining trend. And real estate investment, that is land purchase and construction costs, is also slowing down with huge over supply in lower tier cities. Meanwhile on the credit side Chinese developers still face tight liquidity from banks and from shuttle banks. So why does China's quantitative easing not work. One reason of course is the government stimulus and stocks credit boom helped the financial crises which made the economy over leveraged. And another major reason most recently is the capital flight from China. We have been seeing significant net capital outflow since the second half of last year which Beijing should be worried about because capital flight draws liquidity out of the country. That also explains why the government is aggressively promoting MNB globalization recently. They want MNB to become a reserve currency in IMF special drawing rights so called FDR basket and for China's Asia stocks to be included in major investors such as MSCI and FTSE. The government made these attempts in the hope of keeping capital in the country and hopefully to attract more foreign capital inflows to support the economy and to boost confidence. However in the near term we don't think the capital flight trends could change. At fundamenta in China while US recovery is largely on track and that rate hike is well in sight. So finally about real estate in Hong Kong and in Macaw which actually are quiet interesting dictators of China's economic picture. In Hong Kong residential property sales and demand for office space remains strong thanks to tight near term supply, which is quite different from the over-supply situation in mainland China. However, retail sales in Hong Kong suffered a sharp decline due to China's corruption crack down and a drop of Chinese mainland visitors, with the biggest weakness in luxury goods. Similarly in Macaw grass gaming revenue plummeted due to the same reasons. So overall China is facing big problems today. The government have to deal with excessive capacity, excessive investment, excessive credit, capital flight, pollution, corruption and most lately a stock market bubble which again was fueled by margin financing. So all of these are likely to lead towards a recession and we will see how it works out. With that I will turn it back to Bob to talk about our current allocation.

Bob - 37:35
Thanks Penghui. Our current positioning today, and you can probably tell by some of the comments we've made, when you look at the bar charts we're overweight view as given the valuation attractiveness there. We're overweight in the UK, we have really solid fundamentals there and low cost of capital and currently low supply. And a moderate overweight in Australia as well. Australia has the highest cap rates in the world today. They have higher cost of money but I think with the slowdown in China you are also going to see lower cost of Capital and cap rate compression. As Scott mentioned as Europe has been selling off through REIT fears, rising yields and we are seeing some opportunities there. Specifically in the periphery in Spain and in Finland as well. And underweight, no surprise, Penghui went through the China pieces. China is the slowing economy, you can see they are not buying jewelry they are not buying watches, they are not gambling. They were in reform mode and they realized how that slowed the economy and now they are trying to stimulate but it's pushing on a string. So we are underweight China, we are underweight in emerging markets mainly the emerging markets that are affected by China. Those that exported to China over the past few years that are now seeing a slow down. Such as Brazil, Chile, emerging Asia and even Canada which is seeing a slowdown from exports. And then lastly Japan, the last developed country that had the second largest weighting in the index. Japan has done very well. We actually were very excited about Japan in 2012/2013 when the REITs were selling at 30% discount NAV and as Scott showed they were at a 40% premium. So the Japanese REITs today are the most expensive in the world and we just don't see the value there. Plus there is very little internal growth in Japan, not even 1%. So with big premiums NAV and very little growth we are underweight there to our largest underweight. So overweight US, UK. Moderate overweight Australia, judiciously adding to Europe where we see some value and then underweighting most of Asia and EM.So lastly just to recap and provide four important closing points about investing in REITs. I think first of all the REITs we believe are the preferred structure to own and operate commercial real estate and the success of the US REITs over the last twenty years really you are seeing the adaptation of REITs on a global basis and we will continue to see that as we go. And I think there is reason for this and if you look under the hood of many of these companies it's the high quality, professional management that has a stake in these companies. Great properties, the highest quality properties, far better than direct real estate which the non-traded REITs are buying, better corporate governance, there is some transparency in these companies because they are public companies. And then lastly lower cost of capital, again that is the raw material for this industry. They have to constantly access debt equity capital and they have a lower cost to capital and more funded availability of capital than the private or non traded REITs do. I think that many of your clients probably have an apartment building or maybe they own an industrial warehouse and investing in REITs would give them exposure to seven or eight other sectors. So they give them exposure to offices, hotels, timberlands or data centers. I think it's a great compliment if you have some direct exposure you don't want to sell and you can diversify with a reallocation. And then lastly this outperformance. I think some of the reasons we have mentioned professional management, high quality properties, better corporate governance. REITs have to live by the rules of the public markets, the direct markets don't, the non-traded markets don't. And so they have lower fees they have lower leverage and that all translates into outperformance versus direct market or some of the non-traded as you have seen over time. So outperformance we think has been a big reason why REITs have performed over the cycles, the lower leverage and lower fees as well. And then lastly Scott summarized and explained really well, I think it is important to understand what drives real estate securities valuation. It's not just the underlying real estate but just as important, in many cases almost more important, is the cost and the availability of debt and equity capital. So our ears and eyes are glued to the capital markets and how they view real estate. Remember real estate securities, or REITs have to pay out 90% of their taxable income. So how those capital markets view real estate is very important. Just as important as the underlying fundamentals.

Zoe - 42:37
Thanks Bob that was an excellent way to recap the more formal part of our presentation. Before we get into some questions I think it would be helpful if we would just take the panels opinion here, they are dedicated to REITs and I would like to hear, and I think our audience would like to hear too, what interests you most about the REIT market in the coming year. Anything to be wary of or anything you are looking forward to, to watching in the market, anything you are curious about. So we will start with Bob and then we will take it around the horn here.

Bob - 43:17
Longer term what I like about REITs is the stability of the cash flow. They are contractual long term leases that, regardless of what market rents are doing, have an upward bias due to indexation to inflation. So I like that on a long term basis. Secondly on a shorter term basis valuations are very compelling. We were down about 12 or 13% at the peak in January given interest rate fears and those are the best times to buy REITs, is when perception is they are sensitive to rates but it is clear from this presentation that they are not sensitive to rates over the long term. So I like the stability long term, the growth of the dividend long term and then short term the valuation opportunity.

Scott - 44:02
Now this is Scott. Similar to Bob I think what I am most excited about is start the rise in interest rates, simply put I think the fear of the rise in interest rates is overblown in the market. If you look at the fundamentals in the company, particularly in the US, they are very strong. There is virtually no supply, most companies are growing 3-5% top line growth, which translates to 7% growth on earnings in the US. And today they are trading at very wide discounts to the private market values. Unless you think private market values are going to fall overnight, these are great values. We think that once we can get over this perception view, that there are going to be some great buys here today and in the US this is really going to perform strongly.

Damon - 44:47
This is Damon, I think I would echo a comment I made earlier in the presentation about the change that we just found out about a little earlier this year that will take effect next year and that's the MSCI and S&P 500 Gic codes and real estate being its own Gic code next year. I think that really highlights again the acceptance that REITs have had over their history. I personally started analyzing and investing in REITs back in 1995. So I have kind of grown up with these companies and there has always been a perception of just being a second fiddle in the market place. Like they are too small, we don't have to worry about them. And that definitely evolved over time but I think this next phase of having their own Gic code next year will catapult REITs to the next level. You know right now on a global basis listed real estate companies own roughly about 10% of all institutional quality real estate globally and that has actually been significant growth over fifteen, twenty years. And I think that what we are seeing with the acceptance of the market place, and this move by MSCI and S&P 500 that we can double or even more than double that ownership of real estate per listed real estate companies moving forward.

Penghui - 46:22
This is Penghui. Because I basically focus on Hong Kong/China so for me I see the Chinese government probably will keep easing next year but I would say a turnaround of the economy is unlikely any time soon. So I would stay cautious on China and keep watching the capital flight and follow the money.

Erica - 46:46
Yes some great perspectives from our team here. I mean I know personally as a younger investor who has just started working with an advisor, I'm sure many of you out there are currently working with those late twenties, early thirties demographic that's about to be involved in that great transfer of wealth you might be a little bit curious about how to integrate a REIT into a modest portfolio. One that maybe isn't as robust right now. So can the team talk a little bit about, you know, can younger investors benefit from this kind of diversification in their portfolio.

Bob 47:32
Absolutely I think all investors can benefit but especially younger investors coming out of school and probably have a lot of student debt. You can benefit in the real estate market by buy REITs because if you don't have the down payment, you don't have the money as a twenty three or twenty four year old this is a great way to get that exposure. So when you are looking at your 41K or establishing a 529 you are usually investing in stocks and bonds. Maybe it's large cap or small cap or international and maybe you've got a corporate bond or a high yield bond but this is the fourth asset class and you get exposure to a very deep and growing asset class that has outperformed over time and I think that the REIT market is set up that way to give you that exposure. So it's a great way exposure to another asset class, an asset class that has good yields, steady cash flow, growing dividends and I think it should be a part of all portfolios. We have done some studies in the past which have shown REITs as a part of a portfolio should be anywhere between 7 and 12%. So whatever your risk tolerance is I think all investors, whether you're a young investor or a middle aged investor or even an older investor should benefit from their yield, the stability of the yield and the growth of that yield over time.

Erica - 48:54
We mentioned earlier, and maybe this is a good one for you Damon, can you expand a little bit on the difference between the public and the private REIT?

Damon - 49:02
Sure. I think part of it is explicit in just the title. You know 'public' and 'private' REITs. You know public are obviously listed public companies on the stock exchange, buying and selling just like any other stock. I think the benefits of those are... there is just a handful but first these companies are subject to disclosure and recording requirements on the public market so there is a lot more clarity and information and ability to analyze them. The management teams are held a lot more accountable for their performance and their management and execution of these companies. There is also, I would say critically, a lot more alignment of interests with the management and the companies. Their concentration is a lot more towards the performance of their stock and their ability to perform. And I think also liquidity, we brought that up a few times, liquidity for public REITs is far superior. I mean it's daily liquidity. When you look at private REITs liquidity is significantly less, arguably pretty poor liquidity. There is long lock up periods and it's difficult to assess pricing if there is an immediate liquidity draw. We would say there is conflicts of interest that the management team and the sponsors of private REITs are typically paid on fees and on contracts. Not on increasing shareholder value. And finally again, public REITs are managed as ongoing concerns. Private REITs are typically finite light vehicles and the sponsors and management teams are truly incented to just get in and get out regardless of increase in shareholder value.

Erica - 51:02
Great and with that we can take a few questions here. I have a lot coming in, many of which we actually covered in our presentation today, so I am glad we were able to anticipate some of the questions that you may have had earlier in the presentation and cover it later in the presentation. But one thing that I think might be of interest is to go back to Asia. We have a pretty heavy underweight in Japan amongst the team, can you speak to the success, or lack thereof, of abenomics.

Bob - 51:36
Yes this is Bob. We think that abenomics has certainly helped. You know their quantitative easing is an unprecedented scale in Japan but we think that pricing is reflecting a lot of that potential success and growth that abenomics can bring along. So early on we were market weighting Japan back in 2012 when they first announced abenomics and we were excited about it because the valuations there and all of a sudden you had this catalyst. And what was the catalyst, it was the capital markets. So these stocks went up 60+% on average in 2013. The best performing sector by far within the real estate universe and what is interesting is that the stocks were cheap and the fire that was lit was the quantitative easing announcement. But real estate fundamentals didn't actually improve until 2014, early 2014, when land prices in Tokyo finally went up after six years of flat prices. So this is the importance of capital markets. And then today the capital markets have now priced in a lot of the good growth and no doubt real estate markets are improving but there is very little growth to justify a 41% premium to NAV. So the problem with Japan longer term is it is the most levered nation in the world today and in the history of the world. It is 280% to GEP, they have negative population growth and unless they begin immigration we just don't see how Japan can grow its way out. So the fine line they are playing with quantitative easing is great, it re-liquefied the economy but also weakens the Yen. And being an export nation and that weakening Yen it helps exports but it can also make prices of imported goods, like oil which they do import, far more expensive. So it's a fine balancing act under a lot of debt and we just think that it is already being reflected in pricing. So we are underweight in China.

Erica - 53:43
Another question that we have coming in here, and this will be the last one that we will take this afternoon since we have covered quite a few, are REITs dividends eligible for treatment as qualified dividends?

53:58
No a lot of REITs can be treated as a return of capital, return on capital, and that election is made at the end of the year. That depends on each individual companies cash flow but it's not in qualified. But there are, in the REIT universe, typically in the US around 30ish % tends to be in the return of capital, effectively not taxable.

Erica - 54:25
That sounds great. A lot of our other questions that are coming in are around the continued growth of this market and how sustainable that is and I think you have all done a nice job today explaining where you see the trends going and what your team is going to be working on for the next year.

So I want to say thank you again to our panel for sharing this conversation with us this afternoon. And encourage you to visit Delawareinvestments.com for more information. We have a dedicated financial advisor website and that is at Delawareinvestments.com/financial-advisors. And you can actually hear more regular commentary from the team you heard from today if you visit the insight section of our website. You can subscribe to receive updates when new content is available from this team and from all our investment teams. To learn more about the evolving advisor practice management program you can also visit our website and subscribe to receive content updates. As always feel free to call your Delaware Investments regional director and if you are not sure who that is the information is available at the bottom of all of our web pages at Delawareinvestments.com.

And now the moment you have all been waiting for, your information on CE credits at Delaware Investments we will be taking care of reporting all of you who are eligible for the CFP's this afternoon. And info credit for this event will be emailed to all of you live attendees one hour following the conclusion of our event today. If you have a minute before signing off, again, we would like to hear from you using our survey widget at the bottom of the screen and we would like to thank you again for your participation. Have a great afternoon.


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