2nd Quarter 2014 Commentary - ASTON/Harrison Street Real Estate Fund
2nd Quarter 2014
The real estate investment trust (REIT) market as measured by the Fund’s FTSE/NAREIT All Equity REIT Index benchmark continued on a positive trajectory in the second quarter, delivering a total return of 7.1%. Broader equity markets enjoyed solid returns for the quarter, albeit lagging the performance of REITs. The S&P 500 Index generated a 5.2% total return for the quarter.
The benign interest rate environment is no doubt a contributor to the appeal of REITs and similar asset classes. An unanticipated rise in interest rates, in terms of the magnitude and/or timing of the rate increase, would likely impair REIT performance in the short term—akin to the “taper tantrum” events of May 2013 – June 2013. However, if interest rates increase gradually in response to demonstrable economic growth, then demand for commercial real estate should manifest and the ensuing earnings/cash flow growth of REIT property portfolios could help offset the pressure of eventually higher capitalization rates. Overall, REITs are trading at a capitalization-weighted 3% average premium to net asset value (NAV) by our calculation, which is right in the fair value range of a plus or minus 10% premium/discount range within which REITs have traded more than 90% of the time for the past two decades.
At present, NAVs are being supported by growing portfolio net operating income (NOI) streams and stable-to-declining capitalization rates in most property types. Strong REIT performance during the first half of 2014 appears to be the result of lower interest rates, steady portfolio fundamental performances/growing NOI, rising dividend streams, healthy balance sheets and plain old reversion to the mean following the punk 3% sector total return in 2013.
Anecdotally, a salient theme at the June 2014 NAREIT convention in NYC was the persistency of money (foreign and domestic) seeking U.S. commercial real estate assets, which has kept capitalization rates stable to declining. As a corollary, the vast majority of the REIT management teams noted a strong desire to sell assets to capture the attractive Main Street pricing for portions of their assets, relative to the implied valuations of their share prices. However, the ensuing earnings dilution holds the ambitions in check as the cash flow rates of return on the owned assets cannot be replicated on pricy acquisitions. Rather, selling of assets is being more closely associated with funding much more accretive development and redevelopment within owned portfolios. The NAV creation potential from ‘self-funded’ redevelopment and development represents the preferred use of any property sales proceeds.
For the second quarter, the Fund underperformed the benchmark. Strong performance from hotel owners Chesapeake Lodging and Strategic Hotels & Resorts as well as timber owner Weyerhaeuser aided performance. However, poor performance from two industrial landlords, large-cap Prologis and small-cap STAG Industrial, as well as cellular tower operator Crown Castle, among other positions, impaired overall portfolio relative performance.
Harrison Street Securities
As of June 30, 2014, Chesapeake Lodging comprised 2.68% of the portfolio’s assets, Strategic Hotels & Resorts – 2.85%, Weyerhaeuser – 5.22%, Prologis – 4.55%, STAG Industrial – 2.87%, and Crown Castle – 5.53%.
Note: The Fund is classified as non-diversified and may be more susceptible to risk than funds that invest more broadly. In addition, REITs may decline from deteriorating economic conditions, changes in the value of the underlying property, and defaults by borrowers. Small- and mid-cap equities are considered riskier than large-cap equities due to greater potential volatility and less liquidity.
Before investing, consider the Fund’s investment objectives, risks, charges, and expenses. Contact 800 992-8151 for a prospectus or summary prospectus containing this and other information. Please, read it carefully. Aston Funds are distributed by Foreside Funds Distributors LLC.