Listed and private real estate tend to be correlated over the long term, but correlations turned negative recently, and we believe investors should embrace this relationship as a diversification tool.
KEY TAKEAWAYS
- Private real estate total returns have declined for six consecutive quarters, while total returns for listed REITs have risen 14.4%, outperforming private by nearly 33% in the period.
- Listed and private real estate tend to be correlated over the long term, but correlations turned negative recently, as listed REITs have rebounded while private real estate has declined.
- We believe this lead/lag relationship helps to illustrate that investors should embrace the short-term volatility of listed REITs as a diversification tool.
Listed and private real estate tend to be correlated over the long term, but correlations turned negative recently, as listed REITs have rebounded while private real estate has declined.
In fact, private real estate total returns have declined for six consecutive quarters, while total returns for listed REITs have risen 14.4%, outperforming private by nearly 33% in the period.
Why is that important to investors? The key, we believe, is that this lead/lag relationship helps to illustrate that investors should embrace the short-term volatility of listed REITs as a diversification tool.
Let’s take a closer look at returns and correlations—and how blending listed and private allocations may benefit investors.
1. REIT returns versus private CRE returns
The NCREIF ODCE index, which tracks 25 open-ended funds that own core commercial real estate, is widely used as a measure of private real estate performance. The index has now declined for six consecutive quarters, with a total return of –18.4% since its peak in the third quarter of 2022.
The index’s first-quarter 2024 total return of –2.4% represented capital returns of –3.3% offset by income returns of approximately 1%.
By comparison, total returns for listed REITs have risen 14.4% since 3Q22—outperforming private by nearly 33% over the period (Exhibit 1).
EXHIBIT 1
Cumulative total returns since Q3 2022
At March 31, 2024. Source: NCREIF, Bloomberg, Cohen & Steers. Data quoted represents past performance, which is no guarantee of future results.
We believe this makes sense. We have long argued that listed REITs are a leading indicator for private CRE in both downturns and recoveries.
Listed bottomed when private was still climbing. Now, listed is recovering while private is still in the process of finding its bottom.
2. Correlations between listed REITs and private CRE
This brings us to our second area of analysis: Correlations between year-over-year changes in listed REIT valuations and private CRE valuations.
Listed and private real estate returns tend to be correlated over the long term, reflecting the similar nature of the underlying asset classes. However, looking at shorter time horizons, there’s a clear indication of the lead/lag relationship between listed and private.
Correlations between rolling one-year total returns of listed REITs and private CRE stand at just 16% since 1989 (Exhibit 2).
EXHIBIT 2
Correlation of rolling 1-year returns for Private Real Estate(1) and Listed U.S. REITs(2)
December 31, 1989–December 29, 2023
At March 28, 2024. Source: Morningstar, Bloomberg, NCREIF and Cohen & Steers. 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 will begin. (1) Private Real Estate represented by NCREIF Fund Index—Open-End Diversified Core Equity Index (NFI-ODCE) – Net Total Returns. (2) Listed U.S. REITs represented by the FTSE Nareit All Equity REITs Index.
And they turned negative recently, as listed REITs rebounded while private real estate continued to decline.
However, correlations since 1989 rise to almost 60% when private CRE valuations are lagged just three quarters. And most recent correlations in one-year total returns stand at nearly 100% when the NCREIF ODCE index is lagged four quarters.
3. Adding listed REITs to private CRE portfolios
The third observation to note, which is directly connected to this relationship, is the potential benefits of adding listed REITs to a private real estate portfolio.
By allocating to both listed and private, investors may smooth returns, reduce volatility and mitigate drawdown risk.
And since listed REITs have had higher returns over the long term (versus ODCE funds, net of fees), blending private portfolios with allocations to listed has historically increased annualized total returns.
This may seem counterintuitive at first glance; however, keep in mind that listed REITs and private real estate have low correlations over short time frames. One typically zigs when the other one zags, and this can be used to an investor’s benefit.
The past couple of years bear this out. In 2022, private real estate rose while listed REITs declined. In 2023, listed REITs rose by more than 10 percentage points, and private real estate declined by almost 13%.
Let’s use a simple example of hypothetical portfolios with a range of listed and private real estate allocations (Exhibit 3).
Since 4Q89, a portfolio of 100% private real estate has generated annualized total returns (net of fees) of 5.8%, with a standard deviation of returns of 6.1% and a maximum drawdown over the period of –38.6%.
EXHIBIT 3
Adding listed REITs to private CRE portfolios historically increases returns and mitigates drawdowns
Sensitivity analysis
At March 28, 2024. Source: Bloomberg, NCREIF, Cohen & Steers. 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 will begin. (1) Listed U.S. REITs represented by the FTSE Nareit All Equity REITs Index. (2) Private Real Estate represented by the NCREIF Fund Index—Open-End Diversified Core Equity Index (NFI-ODCE) – Net Total Returns.
If we add a hypothetical 10% static allocation to listed REITs, annualized total returns increase by approximately 60 basis points to 6.4%. Meanwhile, the standard deviation of returns declines to 6.0%, and the maximum drawdown over the period is –35.4%.
This is a simplified example, and these metrics could be improved even more through active management of listed REITs, but we believe it helps to illustrate that investors should embrace the short-term volatility of listed REITs as a diversification tool.
Watch April 2024 The Real Estate Reel: A closer look at Q1 REIT returns and what may be next
Watch all The Real Estate Reel videos.
ABOUT THE AUTHORS
Rich Hill, Senior Vice President, is Head of Real Estate Strategy & Research, responsible for identifying allocation opportunities in both listed and private real estate and related thematic and strategic research.
FURTHER READING
The Retail Renaissance has arrived in private real estate investing
Values of open-air, necessity driven shopping centers have bottomed; a reality that most investors have yet to fully recognize.
A new market regime for REITs
A regime shift to lower rates is a favorable backdrop for REITs, in our view.
The Real Estate Reel: The potential benefits of blending listed REITs and private CRE
Adding listed REITs at certain levels to a private real estate allocation has been shown to increase performance, reduce volatility, and limit drawdowns.
Data quoted represents past performance, which is no guarantee of future results. The information presented 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. There is no guarantee that any market forecast set forth in this paper will be realized. There is no guarantee that any historical trend referenced herein will be repeated in the future, and there is no way to predict precisely when such a trend will begin. The mention of specific securities is not a recommendation or solicitation to buy, sell or hold any particular security and should not be relied upon as investment advice. There is no guarantee that an actively managed investment strategy will outperform the broader market index.
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