Jason A. Yablon
Head of U.S. Real EstateMore by this author
14 minute read
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The diversity and complexity of the modern REIT market give specialist managers a wide field of opportunities to potentially enhance returns.
- REITs have historically been fertile ground for active managers leveraging their information advantage to add potential value for investors.
- The modern U.S. REIT market spans more than a dozen property types, providing a diverse universe for identifying opportunities.
- REIT investing requires an understanding of both real estate fundamentals and listed equity markets, underscoring the importance of fundamental research.
REITs have historically been fertile ground for active managers
When it comes to actively managed investments, not all asset classes are created equal. Among mutual funds rated 4 or 5 stars by Morningstar, which typically oversee the vast majority of investor assets, funds that specialize in real estate investment trusts (REITs) and other real estate securities have generally had a higher rate of outperformance than those providing broad equity exposure (Exhibit 1).
As the track record of the full fund universe shows, delivering outperformance is not commonplace (even in real estate), underscoring the importance of choosing the right manager. However, we have found that a well-resourced manager specializing in REITs can leverage the potential for better-quality information, more accurate and localized forecasts, and faster implementation of investment ideas—simply by being more attuned to shifting market trends. As we will show, this potential is magnified by the many distinct property types represented in the REIT universe, each with its own investment characteristics and economic sensitivities.
REIT managers have a track record of delivering value
% of global and U.S. real estate funds that outperformed their benchmark
At March 31, 2021. Source: Morningstar Direct, Cohen & Steers analysis.
Data represents past performance, which is no guarantee of future results. The information presented above does not reﬂect the performance of any fund or account managed or serviced by Cohen & Steers, and there is no guarantee that investors will experience the type of performance reﬂected above. Morningstar category ratings are as of 3/31/2021 and are subject to change. For each fund with at least a 3-year history, Morningstar calculates its ratings based on a risk-adjusted return measure that accounts for variation in a fund’s monthly performance (including the eﬀects of sales charges, loads and redemption fees), placing more emphasis on downward variations and rewarding consistent performance. In each category for each time period, the top 10% of funds receive 5 stars, the next 22.5% receive 4 stars, the next 35% receive 3 stars, the next 22.5% receive 2 stars and the bottom 10% receive 1 star. Therefore, 4/5-star funds represented here are the top 32.5% of funds in their respective category over a given time period. Data includes current managers with performance records spanning the full period in question. See below for benchmark associations, definitions and additional disclosures.
The modern REIT market offers a diverse opportunity set
When investors think of commercial real estate, they may envision office buildings, malls, shopping centers and apartments. REIT ownership of these kinds of assets exists, of course. However, REITs have become increasingly specialized in new property types over the past 20 years, shifting the REIT market’s composition away from traditional sectors (Exhibit 2).
For well-resourced managers, these new sectors provide a broad selection of REIT- owned assets for constructing portfolios: 200-foot cell towers disguised as trees that lease space to wireless carriers and first-responder networks; secure data centers where companies rent by the kilowatt to connect cloud servers; high-tech distribution hubs that facilitate next-day shipping on e-commerce orders; climate-controlled storage facilities; biotech research labs; and senior living centers, just to name a few.
Alternative property sectors make up over half of today’s U.S. REIT market
U.S. REIT index sector weights (%)
At December 31, 2020. Source: FTSE Nareit index weights, Cohen & Steers analysis.
Values may not sum due to rounding. Examples represent the largest companies by market capitalization within their respective industry. The chart above is for illustrative purposes only and does not reﬂect information about any fund or other account managed or serviced by Cohen & Steers. The mention of specific securities or sectors is not a recommendation or solicitation for any person to buy, sell or hold any particular security in a sector and should not be relied upon as investment advice. As of 3/31/21, the securities mentioned above represented the following weightings within Cohen & Steers Realty Shares: American Tower (6.6%), Crown Castle (3.2%), SBA Communications (4.0%), Equinix (3.1%), Digital Realty Trust (3.1%), Welltower (0.3%), Ventas (2.9%). Healthpeak Properties (5.2%), Public Storage (7.1%), Extra Space Storage (3.6%), Invitation Homes (1.9%), Sun Communities (2.5%), Equity Lifestyle Properties (0.0%), Prologis (3.1%), Duke Realty (4.9%). See below for index associations, definitions and additional disclosures.
Capitalizing on distinct sector characteristics
REIT sectors and companies tend to respond to market conditions very differently depending on factors such as lease durations, types of tenants, economic drivers and supply cycles. These differences have historically resulted in a wide dispersion of sector returns in any given period (Exhibit 3).
More economically sensitive sectors with short lease terms, such as hotels and self storage, can adjust rents relatively quickly to capture accelerating demand in a cyclical upswing. By contrast, longer-lease sectors like net lease and health care have more defensive cash flows that may be more resilient during economic downturns. In 2020, the best and worst sectors were separated by 58 percentage points as the pandemic upended retail, hotels and offices, but benefited technology-related REITs amid acceleration in e-commerce and working from home.
Different characteristics often result in a wide dispersion of returns in any given year (left), while some sector trends can last many years (right)
At December 31, 2020. Source: FTSE Nareit, Cohen & Steers. Sector returns represented by the FTSE Nareit All Equity REITs Index.
Data quoted represents past performance, which is no guarantee of future results. The information presented above does not reﬂect the performance of any fund or account managed or serviced by Cohen & Steers, and there is no guarantee that investors will experience the type of performance reﬂected above. The mention of specific sectors is not a recommendation or solicitation to buy, sell or hold a particular security and should not be relied upon as investment advice. See below for index associations, definitions and additional disclosures.
Navigating secular growth opportunities and challenges
As the economic cycle progresses, we believe property types are likely to have different fundamentals, especially in an environment of potentially rising interest rates and inflation. Many sectors and cities may also feel lasting effects from the pandemic. Flexible work-from-home policies could change how and where people want to work and live. Many residents are moving from dense cities to suburban markets or lower-cost states.The pandemic has also accelerated the growth of e-commerce in a way that we believe is unlikely to be reversed, supporting demand for technology-related real estate.
Anticipating secular trends such as these is a key component of active management. For example, an active manager who understood the potential impact of e-commerce on different types of real estate could have sought to capitalize on diverging fundamentals in industrial and regional mall properties over the past five years, which contributed to a 245 percentage point difference in cumulative returns (Exhibit 3, right). By contrast, passive portfolios are, by design, not able to allocate assets to capitalize on potential secular growth opportunities, nor can they sidestep sectors that may be facing long-term headwinds. (Of course, there is no guarantee that active management can successfully navigate these trends.)
Investing in the two worlds of real estate and listed equities
Generalist fund managers tend to give little attention to real estate, which accounts for just 3% of the MSCI World Index. This lack of deep analysis, combined with a typically high level of REIT ownership by generalist investors and passive vehicles, may create potential pricing inefficiencies that REIT specialists can exploit. REIT managers commit time and resources to understanding both real estate fundamentals and the factors that may affect listed equity performance.
For example, in a typical year, Cohen & Steers may conduct 300 property visits and 1,300 meetings with U.S. REIT management teams, seek local perspective from independent brokers, and leverage proprietary data sets, such as web scraping tools that provide unit pricing information in real time. Using inputs such as these, we can often take a differentiated view on the direction of property cash flows and asset values, identifying securities with upside potential that other equity investors may have underestimated.
Focusing on results vs. costs
Despite the popularity of exchange-traded funds, we continue to see growing interest in active REIT management. We see this as a recognition that certain markets such as real estate may be better suited for adding potential value. For example, Cohen & Steers Realty Shares, one of the first REIT open-end mutual funds, has delivered a net return of 11.5% per year since its inception in July 1991, outperforming its benchmark as well as stocks and bonds (Exhibit 4). Although managing investment expenses is important, we believe an active REIT strategy in an overall asset allocation may actually be in an investor’s best interest.
A skilled active REIT manager has the potential to enhance returns over time
Growth of $100K since 1991
At March 31, 2021. Source: Morningstar Direct, Cohen & Steers.
The Fund’s gross and net expense ratios are 0.97% and 0.88%, respectively. As disclosed in the May 1, 2021, prospectus, Cohen & Steers Capital Management, Inc., the Fund’s investment advisor (the “Advisor”), has contractually agreed to waive its fee and/or reimburse expenses through June 30, 2022, so that the Fund’s total annual operating expenses (excluding acquired fund fees and expenses, taxes and extraordinary expenses) do not exceed 0.88% for Class L shares. Absent such arrangements, returns would have been lower.
This contractual agreement can only be amended or terminated by agreement of the Fund’s Board of Directors and the Advisor and will terminate automatically in the event of termination of the investment advisory agreement between the Advisor and the Fund. Prior to July 1, 2019, Cohen & Steers Realty Shares had only one class of shares outstanding; these shares have been redesignated as “Class L” shares. Because Class A shares did not commence investment operations prior to July 1, 2019, performance information represented above is for Class L shares. Returns for other share classes will diﬀer due to diﬀering expense structures and sales charges. The maximum sales charges for Class A shares is 4.5%.
Data quoted represents past performance, which is no guarantee of future results.
Current performance may be lower or higher than the performance quoted. The investment return and the principal value of an investment will ﬂuctuate and shares, when redeemed, may be worth more or less than their original cost. Month-end performance information can be obtained by visiting our website at cohenandsteers.com. Periods greater than 12 months are annualized. See below for index definitions
Index definitions and important disclosures
Please consider the investment objectives, risks, charges and expenses of the Fund carefully before investing. A summary prospectus and prospectus containing this and other information may be obtained by visiting cohenandsteers.com or by calling 800 330 7348. Please read the summary prospectus and prospectus carefully before investing.
Risks. There are special risks associated with investing in the Fund. All investments involve risks, including loss of capital, and there is no guarantee that investment objectives will be met. The Fund is subject to special risk considerations similar to those associated with the direct ownership of real estate due to its policy of concentration in the securities of real estate companies. Real estate valuations may be subject to factors such as changing general and local economic, financial, competitive and environmental conditions. The Fund is classified as a “non-diversified” fund under the federal securities laws because it can invest in fewer individual companies than a diversified fund. However, the Fund must meet certain diversification requirements under the U.S. tax laws.
An investor cannot invest directly in an index and index performance does not reflect the deduction of any fees, expenses or taxes. Index comparisons have limitations as volatility and other characteristics may differ from a particular investment. U.S. REITs: The FTSE Nareit All Equity REITs Index contains all tax-qualified REITs with more than 50% of total assets in qualifying real estate assets other than mortgages secured by real property that also meet minimum size and liquidity criteria. “FTSE®” is a trademark of the LSE Group and is used by FTSE International Limited (“FTSE”) under license. “NAREIT®” is a trademark of the Nareit. All rights in the FTSE Nareit All Equity REITs Index and FTSE EPRA Nareit Developed Index (the “Indexes”) vest in FTSE and Nareit. Neither FTSE, nor the LSE Group, nor Nareit accept any liability for any errors or omissions in the indexes or data and no party may rely on any indexes or data contained in this communication. No further distribution of data from the FTSE or Nareit is permitted without the relevant FTSE’s express written consent. FTSE, the LSE Group, and Nareit do not promote, sponsor or endorse the content of this communication. U.S. stocks: The S&P 500 Index is an unmanaged index of 500 large- capitalization stocks that is frequently used as a general measure of U.S. stock market performance. U.S. bonds: Barclays Capital U.S. Aggregate Bond Index is a broad-market measure of the U.S. dollar-denominated investment- grade fixed-rate taxable bond market, and includes Treasuries, government-related and corporate securities, mortgage-backed securities, asset-backed securities, and commercial mortgage-backed securities.
This presentation is for informational purposes, and reﬂects prevailing conditions and our judgment as of this date, which are subject to change. There is no guarantee that any market forecast set forth in this presentation will be realized.
This material represents an assessment of the market environment at a specific point in time and should not be relied upon as investment advice, does not constitute a recommendation to buy or sell a security or other investment and is not intended to predict or depict performance of any investment. This material is not being provided in a fiduciary capacity and is not intended to recommend any investment policy or investment strategy or take into account the specific objectives or circumstances of any investor. We consider the information in this presentation to be accurate, but we do not represent that it is complete or should be relied upon as the sole source of appropriateness for investment. Please consult with your investment, tax or legal professional regarding your individual circumstances prior to investing.
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Cohen & Steers Capital Management, Inc. (Cohen & Steers) is a registered investment advisory firm that provides investment management services to corporate retirement, public and union retirement plans, endowments, foundations and mutual funds.
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