Index investing reached a milestone in early 2024, with assets in passive investment vehicles surpassing actively managed strategies for the first time. But passive isn’t necessarily better. Over the past 10 years, active real estate managers have outperformed their benchmarks at more than twice the rate of passive funds, and the magnitude of excess returns versus passive strategies has often been significant (Exhibit 1).

We believe this advantage stems from the time and resources REIT managers devote to understanding current real estate fundamentals and the factors that may affect listed equity performance. This focus creates the potential for better-quality information, more accurate forecasts and faster implementation of investment ideas, achieved simply because these managers are more attuned to shifting market trends. For example, in the five years ended March 31, 2024, the median U.S. REIT manager proved adept at helping to mitigate the challenging effects of Covid-19 and rising interest rates on certain types of real estate.

At March 31, 2024. Source: eVestment Alliance, Cohen & Steers.
Data quoted represents past performance, which is no guarantee of future results. There is no guarantee that investors will experience the type of performance reflected above. Data includes current managers with performance records spanning the full period in question. Sharpe ratio is an indication of risk-adjusted performance, represented here by dividing the annualized total return by the standard deviation. See endnotes for additional disclosures.

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 since 2000, 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, many of which have secular growth drivers. These include data centers where companies rent by the kilowatt to connect cloud servers; cell towers that lease space to wireless carriers for 5G networks; high-tech distribution hubs that facilitate next-day shipping on e-commerce orders; climate-controlled food storage facilities; biotech research labs; and senior living centers, just to name a few.

Size and composition of the modern REIT universe

At March 31, 2024. Source: FTSE Nareit, Cohen & Steers.
Sectors represented by the FTSE Nareit All Equity REITs Index. 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. There is no guarantee that any historical trend illustrated above will be repeated in the future, and there is no way to predict precisely when such a trend might begin. See endnotes for index associations, definitions and additional disclosures.

The listed real estate universe encompasses 17 major property types, spanning dozens of developed and emerging markets. Each sector has distinct characteristics, including lease durations, types of tenants, economic drivers and supply cycles. Countries and regions may also have different property cycles, monetary policies and business practices. These factors typically result in a wide dispersion of returns in any given period (Exhibit 3).

The average dispersion in returns between the best- and worst-performing U.S. REIT sectors over the last five years was more than 50% annually. An array of factors can potentially drive returns. Over a typical market cycle, for instance, more economically sensitive sectors with short lease terms, such as hotels or self storage, may outperform in periods of accelerating demand, as they can adjust rents relatively quickly. By contrast, longer- lease sectors like net lease and health care may be more resilient during economic downturns due to their more defensive cash flows.

By focusing on what’s occurring in different companies, property types and countries, active REIT fund managers can emphasize allocations in areas they believe can outperform (and underweight or avoid altogether areas they expect to underperform). By design, passive portfolios are not able to allocate assets to benefit from potential secular growth opportunities, nor can they sidestep potential sector calamities.

Best/worst total return (US$)

At December 31, 2023. 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. There is no guarantee that any historical trend illustrated above will be repeated in the future, and there is no way to predict precisely when such a trend might begin. See endnotes for index definitions and additional disclosures.

Understanding the many drivers that may affect a real estate company’s financial performance requires a commitment to fundamental research. For example, in a typical year, Cohen & Steers may conduct 300 property visits and 1,300 meetings with management teams, seek local perspectives 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, plus a view on future supply and demand, a REIT manager can often take a differentiated view of where cash flow and asset values are pointing to in the future. Using inputs such as these, we can often develop a differentiated view of the direction of property cash flows and asset values, identifying securities with upside potential that other equity investors may have underestimated (Exhibit 4).

The listed real estate market is historically inefficient, as generalist and passive investors can collectively dominate ownership. As such, specialist managers can seek to leverage the information advantage they hold—their deeper insights into factors that drive sector and company performance—to uncover unique opportunities.

U.S. REIT sectors 2024E rent growth vs active weights

At March 31, 2024. Source: Morningstar.
Data quoted represents past performance, which is no guarantee of future results. There is no guarantee that any historical trend illustrated above will be repeated in the future, and there is no way to predict precisely when such a trend might begin. Data is based on a list of representative companies by sector selected by Cohen & Steers as a representative of the market. 2024E rent growth represents Cohen & Steers estimated full-year market-level rent growth. Assumptions based on representative companies by sector. Rent growth assumptions are not guaranteed and actual results could vary materially. Active weights is represented by the Cohen & Steers U.S. Realty Total Return representative portfolio. We believe this is the most appropriate portfolio as it best represents the strategy’s composition and investment objective. See end notes for index associations, definitions and additional disclosures.