Perception Versus Reality in Listed

Real Estate: More Than Meets the Eye

INSIGHTS | GLOBAL LISTED REAL ASSETS TEAM | December 2023

KEY TAKEAWAYS AUTHORS

  Negative headlines about commercial real estate LAUREL DURKAY, CFA

(CRE) neglect nuance and variations Managing Director

Head of Global Listed
Real Assets (GLRA)
 There’s a wide array of fundamentals within CRE
SIMON ROBSON
sectors and secular drivers impacting longer-term BROWN
Managing Director
growth prospects Head of European
Listed Real Estate
  The office sector is uniquely challenged by new debt
CHRISTOPHER
and equity capital sourcing FREMANTLE, CFA
Executive Director
  CRE banking system contagion fear is overblown and European Listed
Real Estate
underlying collateral for majority of loans is strong
NICHOLAS
CRE has been navigating a treacherous path amid rising interest rates, D’AMBROSIO
Analyst
macroeconomic uncertainty, and stubborn inflation. To make matters worse, U.S. Listed Real Estate
emerging from the COVID-19 pandemic, changes in how we live, work, and
play are exacerbating problems for some types of CRE. Nonetheless, we
believe some of these macroeconomic dynamics are improving and there are
opportunities for investors who are willing to look more closely.

“While offices may continue to be

featured prominently and negatively
in headlines, they represent a small
and declining part of the investment
universe.”
DISPLAY 1
FTSE Nareit All Equity REITs Index YTD Returns as of October 31, 2023

30% 25.1%
18.5% 18.4%
20%
YTD Total Return (%)

10% 5.4%
0%
-1.0% -1.2% -3.0%
-10% -5.6%
Overall Total Return -8.6% -8.1% -8.3%
-10.8%
-20% -14.5% -14.9% -15.6%
-18.8%-20.0%-20.9%
-30%

-40% -34.5%

Timber

Apartment

Manufactured
Housing
Skilled
Nursing

Data

Net Lease
Ex Retail

Storage

Retail
Centers

Seniors
Housing

Single
Family

Malls

Shopping
Regional

Hotels

Centers

Billboards

Net Lease

Towers

Office

Life
Science
Industrial/
Logistics
Source: FTSE Nareit and Morgan Stanley Investment Management
Returns provided in USD terms. Past performance should not be construed as a guarantee of future performance. It is not possible to invest in an index. Groupings are based on
how the investment team views the real estate securities universe and do not reflect official groupings. Provided for illustrative purposes only.

A deeper look at sector returns office loans will cause banks to implode Looking more broadly at loans in the
within listed real estate highlights this is not based on reality. Office real estate U.S., multifamily residential real estate
dichotomy. The U.S. REIT market is an comprises a fraction (approximately comprises nearly half of all CRE mortgage
example of how not all CRE is created 18%1 in Europe and 17% in the U.S.2) of debt. In most cases, multifamily residential
equal. While sectors such as offices CRE loans, making overall office loan is better positioned because it lacks core
may continue to struggle, many forms exposure as a percent of total loans secular pressures that hinder some other
of real estate, including data centers, in the low single digits, while offices types of real estate due to the need for
single-family rental housing, and represent approximately 27% of U.S. shelter, creating a better store of value,
seniors housing are thriving (Display 1). CMBS exposure.3 and immunity from obsolescence.

CRE continues to generate negative

headlines, largely because of concern
DISPLAY 2
over debt capital markets and the
Bank CRE Loan as % of Total Loan Exposure by Country
office segment. Notably, we believe the
old fears that CRE could take down the 20% 18%
banking system are overblown. Banks
CRE Loans as % of Total Loans

are better capitalized now than during

15%
the Global Financial Crisis and, as per
Display 2, have manageable exposure 10% 10%
10% 10%
to CRE. Moreover, even the underlying
delinquencies within CRE are low 7% 6% 6%
5%
compared to prior levels. 5% 3% 3%
In our view, the concern about office
fundamentals and valuations, and 0%
US Ireland Austria Nordics Italy Germany France Benelux Spain UK
offices’ ability to tap the debt markets,
is valid. However, the concern that Source: Moody’s Analytics and IMF for U.S. data as of March 2023; Morgan Stanley Research for European data as of
Sept. 30, 2023, or last reported based on publicly available data from listed banks.

1
European Central Bank Banking Supervision as of August 17, 2022
2
Mortgage Bankers Association as of April 28, 2023
3
Mortgage Bankers Association as of September 30, 2022

2 PERCEP TION VERSUS RE ALIT Y IN LISTED RE AL ESTATE: MORE THAN MEE TS THE E YE | DECEMBER 202 3
Additionally, as the workplace of Return to Office? rates in most of the U.S. continue to
tomorrow takes hold, even within the Office vacancy rates vary greatly increase, with New York at 14% and San
more challenged office sector—which across the globe, as do utilization Francisco at 20% (See Display 3).
represents a mere 3.3% of the U.S. rates of buildings that are technically Moreover, office utilization rates are
index and 13.7% of the global index4 — occupied.5 Vacancy is relatively stable around 60% to 65% in European cities
there will be winners: building quality, in many central business district (CBD) with an upward bias, and have stagnated
sustainability, and location will be more locations in Europe, hovering around and maxed out at about 50% in coastal
important than ever. 8% in London’s West End and 3% in U.S. cities, as shown in Display 4.
the Paris CBD. Meanwhile, vacancy

DISPLAY 3
Office Vacancy Rates by City

30%

20%
20%
17% 16% 16% 16%
15%
14%

10% 9%
8% 7%
5%
3% 2%
0%
San Austin Chicago Washington LA NY Miami London Berlin Paris Melbourne Tokyo Seoul
Francisco DC WE CBD

U.S. Europe Asia Pacific

Source: Costar. PMA, Morgan Stanley Real Estate Investing (MSREI) Strategy, November 2023

DISPLAY 4
Office Utilization Rates by City

100% 94%

80%
80% 74%
65% 66%
60% 58% 60% 61%
60%
48% 50% 47%
43%
40%

20%

0%
San Washington NYC Austin London Stockholm Madrid Paris Melbourne Sydney Brisbane Tokyo Seoul
Francisco DC

U.S. Europe Asia Pacific

Source: JLL, MSREI Strategy, as of September 2023

4
As of October 31, 2023. U.S. Index represented by FTSE Nareit All Equity REITs Index; Global Index represented by FTSE EPRA Nareit Developed Extended Index.
Groupings are based on how the investment team views the real estate securities universe and do not reflect official Index provider groupings
5
The buildings are occupied in that they are being leased, but the office is not being utilized.

DECEMBER 202 3 | PERCEP TION VERSUS RE ALIT Y IN LISTED RE AL ESTATE: MORE THAN MEE TS THE E YE 3
“Globally, the office market is also likely to benefit from the strongest
long-term secular growth drivers
moving toward shorter leases with more within the REIT universe.

flexibility for tenants. This increases „ SENIORS HOUSING: The necessity-based

nature of seniors housing demand is
operating risk, but offers opportunities anticipated to insulate fundamentals
from macro headwinds. Labor
to strong platforms to gain market shortages and expense pressures

share and extract higher cash returns

that were a problem throughout the
COVID-19 pandemic, are dissipating.

from their portfolios.” The aging U.S. population, as

evidenced by the growth within the
80-plus age cohort, is expected to
However, even within more challenging Where is the Opportunity? serve as a significant demand driver
cities, there are examples of real for seniors housing through the
While the office sector continues to
fundamental strength within trophy remainder of the decade, with a
pose challenges for investors due to
office buildings. For example, Owen compound annual growth rate in
difficult fundamentals and continued
Thomas, CEO of Boston Properties excess of 4% through 2030.
value impairment, there are select
(BXP, the largest publicly traded opportunities within the sector. „ SINGLE-FAMILY RENTAL HOUSING: The
developer, owner, and manager of However, more importantly, there undersupply of single-family homes
premier workplaces in the U.S.) said are multiple subsectors of real estate in the U.S. coupled with higher
on the company’s third quarter 2023 with fundamental strength and mortgage rates should serve as a
earnings conference call that: “For the opportunity, including: long-term growth driver for the
last 11 quarters, net absorption for sector. The U.S. has a shortage of
the premier (office) segment was a „ DATA CENTERS: Data growth
approximately five million homes
positive 8.1 million square feet versus facilitating the digital economy and
versus what is needed to house the
a negative 30.8 million square feet for new technologies, including artificial
current population. Additionally,
the balance of the market, and asking intelligence (AI), continues to provide
home ownership affordability
rents are 44% higher for the premier a robust backdrop for new data
remains low with monthly
workplace segment. Including two center demand. New supply is more
differentials of buy versus rent at
buildings undergoing renovation, 94% limited than it has been historically,
historic spreads. Lack of affordability
of BXP’s CBD space is in buildings due to power availability challenges
increases demand for single-family
rated by CBRE as premier workplaces, which have resulted in a favorable
rental homes. As the population
which has been important in driving the environment for landlords to
continues to increase, demand within
increasing office attendance statistics increase rents. We expect these
the sector is expected to remain
in our buildings and is a critical challenges to remain a critical issue
strong. We believe this broader
differentiator for BXP in the leasing going forward, and advancements in
thematic trend of the undersupply of
marketplace.” Globally, the office AI have been an incremental demand
housing will fuel fundamentals for
market is also moving toward shorter driver to the sector. We believe data
years to come.
leases with more flexibility for tenants. center real estate investment trusts
This increases operating risk, but offers (REITs) provide a compelling
opportunities to strong platforms to opportunity for investors not only
gain market share and extract higher over the short term, but potentially
cash returns from their portfolios. for the next decade, as the sector is

4 PERCEP TION VERSUS RE ALIT Y IN LISTED RE AL ESTATE: MORE THAN MEE TS THE E YE | DECEMBER 202 3
DISPLAY 5
Valuations by Region
Equity Multiple P/NAV (%)

25x 30

20

10
20x
0

-10
15x 16x -20
-15
13x 13x 13x -30 -24
-29
10x -40 -35
Global Asia Europe U.S. Global Asia Europe U.S.

■ 10-Year Range ● 10/31/23 ■ 10-Year Range ● 10/31/23

Source: UBS Global Real Estate Research, Datastream

Security and Sector Selection family rental housing. We are actively within listed real estate investing. While
is Vital as Valuations Remain managing subsector exposures and offices may continue to be featured
Attractive closely monitoring valuations as prominently and negatively in headlines,
Valuations remain attractive with we seek to identify the real estate they represent a small and declining
equity multiples and price/net asset securities with the best total expected part of the investment universe.
value trading at or close to trough returns for clients. In contrast, we believe there are
valuations globally and in each compelling opportunities in many other
region (see Display 5), although Conclusion forms of CRE. The Morgan Stanley
security and sector selection are key The sectoral composition and Investment Management (MSIM)
to outperformance. In the current differentiation among the REIT GLRA Team seeks to take advantage of
environment, we are underweight universe is vital when thinking about opportunities presented by secular and
offices, but do have select exposure and analyzing the underlying risk/ cyclical trends and attractive valuations
to best-in-class office landlords. reward profile and performance of real as we ultimately strive to identify the
Additionally, we are overweight data estate securities, and helps to create real estate securities with the best
centers, seniors housing, and single- opportunities for active managers forward total returns.

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