The global index was down 3% in EUR at the beginning of May[1]. Most of the pain came in April as expectations for interest rate cuts have been delayed by inflation proving stubborn in many countries.
This is reflected in weak returns across most regions, with Europe (-4%) and the US (-5%) among the biggest laggards so far this year[2]. In the US, where the expected number of interest rate cuts this year has fallen from six to one or two, higher-for-longer borrowing costs have been compounded by falling commercial real estate values, with offices estimated to be a third lower than pre-Covid levels on average and up to 60% cheaper in some cities[3].
Closer to home, Nordic real estate has struggled in 2024 with the market down 8% year-to-date, largely driven by Sweden where investors remain concerned about debt levels[4]. The Nordics was one of the strongest real estate markets at the end of 2023, closing the year 50% higher than its October lows, so it is unsurprising that it has reverted alongside other regions⁴.
Sweden was a profitable market for SKAGEN m2 last year, thanks to successful stock selection, and fund performance has held up relatively well this year despite our overweight exposure to Swedish real estate (12% of assets vs. 2% of the index). At the end of April, we lagged the global benchmark by around 2% year-to-date but remain ahead over 1-, 3-, 5- and 10-year periods, as well as since inception in 2012.
Our portfolio overall continues to perform well with the holdings reporting solid results mostly in line with expectations. The fund is also well-positioned for when interest rates start to fall, including the recent additions of Helios Towers and Nexity which you can read about in our first quarter report.
Improving financial conditions
We expect the performance of listed real estate in the short-term to remain driven by macro news. However, with inflation expected to fall towards US and European central banks’ 2% targets this summer, it looks increasingly likely that the economic headwinds which have disrupted the sector in recent months will soon turn positive.
At its latest meeting, the Fed reaffirmed that there are unlikely to be further interest rises despite sticky inflation and futures markets currently expect borrowing costs to start steadily falling in the second half of 2024 across both sides of the Atlantic. From this point in previous cycles, listed real estate has outperformed both direct real estate and the broader equity market:
Rather than speculating on central banks’ decisions and their timing, it is better to focus on the longer-term interest rate trend and use the opportunities created by falling prices. Valuations generally remain below long-term averages but there are signs that we have reached the bottom and the sharp slowdown in the construction of new assets should also be positive for long-term values.
In the US, where SKAGEN m2 has the majority (36%) of its assets, REITs currently trade at a 15% discount to NAV with only the data centre segment trading at a premium and others, notably offices, priced at deeply discounted valuations:
The SKAGEN m2 portfolio is cheaper than the overall market using multiples of Price/Book and EV/EBITDA. Some of the discount is explained by its overweight positioning in Sweden, where exposure is also at an all-time high for the fund.
Swedish real estate remains deeply out-of-favour among international investors due to the recent market turmoil and ongoing concerns over leverage. However, with a 50/50 chance of rate cuts starting as early as this month or next according to the latest estimates, Sweden could well be one of the first countries to benefit from looser monetary policy. The Swedish economy is also expected to grow faster than the Eurozone in 2025 which should provide a further headwind from rising property prices[5].
Our portfolio is currently invested in 31 companies which are diversified across countries, economic drivers and sub-sectors. The majority of assets are invested in companies with exposure to logistics / warehouse (27%), digital infrastructure (21%) and residential rental (17%), all segments which should benefit from improving short-term financial conditions and with attractive long-term demand drivers.
We continue to be disciplined in our choice of holdings, reflected in their solid balance sheets and highlighted by stock selection continuing to have a strong positive effect on portfolio returns. With the fund well positioned for lower interest rates that finally appear within sight, the outlook for SKAGEN m2 and our unitholders looks increasingly positive.
NB: SKAGEN m2 portfolio data as at 31/03/2024.
[1] MSCI ACWI Real Estate Index as at 30/04/2024.
[2] Source: NAREIT in EUR as at 30/04/2024.
[3] Source: Real Capital Analytics.
[4] Nasdaq Real Estate Index (N35EURGI) in EUR.
[5] Source: IMF World Economic Outlook, April 2024.