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.

EXHIBIT 1

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.

EXHIBIT 2

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.

EXHIBIT 3

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.

EXHIBIT 4

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