Index investing reached a milestone in early 2024, with assets in passive investment vehicles surpassing those in actively managed strategies for the first time. On the surface, the appeal of index investing is compelling: passive exchange-traded funds (ETFs) offer lower costs. And, in the case of broad-based equity and bond categories, active managers frequently fail to consistently outperform their benchmarks. But cheaper is not always better, and not all markets are alike.

Real estate is one area of the equity market that lends itself to active management. REIT managers who commit time and resources to understanding current property fundamentals, shifting market trends and factors that may affect listed equity performance can potentially spot pricing inefficiencies and rapidly implement plans to generate excess returns. We believe this advantage is reflected in the performance of the largest active REIT mutual funds relative to passive investment vehicles, despite active funds typically having greater expense ratios (Exhibit 1).

Weighted-average total returns top 10 active funds vs. top 10 passive funds

At March 31, 2024. Source: eVestment Alliance, Cohen & Steers analysis.
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. Assets under management-weighted average total returns of the 10 largest actively managed open-ended real estate mutual funds by assets under management and 10 largest passively managed exchange-traded funds. Analysis reflects total returns net of fees. 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.

At March 31, 2024. Source: FTSE Nareit, Cohen & Steers.
Sector represented by the FTSE Nareit All Equity REITs Index. 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.

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 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 2023, returns between the best and worst sectors were separated by 38 percentage points. In other years, the dispersion has been considerably greater.

We have observed that the difference in returns at the security level within each sector is often similar to the variance at the sector level. We believe this dispersion highlights the opportunities active managers have to enhance returns through both sector and stock selection.

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.

As economic cycles progress, property types are likely to have different fundamentals. For instance, the pandemic upended retail, hotels and offices, but benefited technology-related REITs amid acceleration in e-commerce and working from home. And many sectors and cities continue to feel the lasting effects of the pandemic as flexible work-from-home policies have changed how and where people want to work and live, creating an uncertain outlook for offices. Consequently, high-quality offices may continue to see healthy demand, while lower-quality assets may experience soft demand for years to come—a distinction not likely to be reflected in passive portfolios.

Active managers can also add value by capitalizing on regional differences and trends. Many U.S. residents are moving from dense, high-cost Northern and Coastal cities to lower-cost markets in the Sunbelt. In global portfolios, REIT managers may assess geographic regions to understand local property supply and demand fundamentals, economic trends, monetary policy and other factors that may affect the operating performance of different real estate companies, as well as the markets valuation relative to other regions.

Anticipating secular trends such as these is a key component of active management, since they can present opportunities for active managers to capitalize on diverging fundamentals. For example, the divergence in industrial and office properties (Exhibit 3).

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.

REIT managers may also invest based on relative value, seeking to allocate portfolio assets based on merit rather than market capitalization, as is often the approach for many passive index funds.

Investing outside the benchmark—participating in special opportunities such as recapitalizations, private placements, initial public offerings (IPOs) or pre-IPO investments—is another way for active managers to add value. These activities are not within the scope of passive index-tracking strategies—a notable disadvantage in recent years due to the inability of passive vehicles to get out of the way of the secular declines in retail and offices.

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Active REIT managers seek to understand both real estate fundamentals and the factors impacting equity performance to generate excess returns, or alpha. 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 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.

Despite the popularity of ETFs, interest in active REIT management is increasing. We see this as recognition that real estate is better suited for adding potential value. For example, Cohen & Steers Realty Shares, one of the first REIT open-end mutual funds, has delivered an annualized return net of fees of 10.7% since its July 1991 inception (Exhibit 4). While managing investment costs is crucial, we think an active REIT strategy in an overall asset allocation should be considered.

Percentile ratings: Cohen & Steers Realty Shares vs. Morningstar category peers

At March 31, 2024. Source: Morningstar.
Data quoted represents past performance, which is no guarantee of future results. Returns stated are net of fees. Current performance may be lower or higher than the performance quoted. The investment return and principal value of an investment will fluctuate and shares, when redeemed, may be worth more or less than their original cost. Periods greater than 12 months are annualized. Returns are historical and include change in share price and reinvestment of all distributions. Month-end performance information can be obtained by visiting our website at cohenandsteers.com. Gross Expense Ratio Class L: 0.93%, Net Expense Ratio Class L: 0.88%. As disclosed in the May 1, 2024 prospectus, Cohen & Steers Capital Management, Inc. has contractually agreed to waive its fee and/or reimburse expenses through June 30, 2025 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. 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, Class C, Class I, Class R and Class Z 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. U.S. REIT Funds represented by Morningstar’s U.S. Open-Ended Real Estate category, which consists of domestic real estate portfolios primarily investing in real-estate investment trusts (REITs). Prior to 3/31/19, the benchmark was the FTSE Nareit Equity REITs Index. Thereafter, it is the FTSE Nareit All Equity REITs Index. ©2024 Morningstar, Inc. All Rights Reserved. Morningstar and/or its content providers are the proprietors of this information; do not permit its unauthorized copying or distribution; do not warrant it to be accurate, complete or timely; and are not responsible for damages or losses arising from its use.