Portfolio Managers, Greg Kuhl and Danny Greenberg, discuss how real estate investment trusts (REITs) have held up through the pandemic and explain why they believe the asset class is positioned for growth as economies reopen.
We see three potential benefits of investing in listed REITs are diversification, dividends and dependable growth.
COVID accelerated many long-term trends such as the proliferation of e-commerce, which was already shaping commercial real estate pre-pandemic.
Innovation in established property types such as industrial space, and growth in newer property types such as lab space and gaming, make it an exciting time to invest in REITs.
Greg Kuhl: Listed REITs trade on major equity exchanges globally on a daily basis. Some of the key benefits of that asset class we think are really three things, dividends, diversification and dependable growth. REIT legislation was introduced back in the 1960s in the US and the tax efficiency means that these companies don't pay federal income taxes to the extent that they distribute the vast majority of their income. From a diversification perspective, REITs and commercial real estate is really interesting because it gives you lower correlations with equities and also with fixed income.
And then on dependable growth, commercial real estate, for the most part is based on contractual lease income. That's what gives you kind of the dependable income aspect but unlike a fixed income type vehicle, those rents typically grow every year. One element of listed REITs that's unique and interesting compared to some private real estate vehicles, is the ability they have for external growth, meaning going out and acquiring buildings or acquiring other companies. Because they're public equities, they can issue stock on an opportunistic basis and that's an advantage they have that can deliver growth in excess of kind of the annual escalations that their lease contracts would give.
2. In an inflationary environment, can REITs offer some protection?
Danny Greenberger: A unique feature of the REIT market is the asset class’s ability to deliver growth in excess of inflation over time. The drivers of this growth have been escalators that are baked into leases that are either linked to explicit rates of CPI or escalate at rates of 3% to 4% based on the underlying strength in a particular property type. For companies that don't offer explicit inflation-linked leases with their tenants such as the shorter-term lease sectors like apartments, those companies have the opportunity to increase and reset rents on an annual basis when leases expire. When looking back historically, the sector has grown its dividend at roughly 3% to 4% a year,* which has trounced the rate of US CPI historically going back to the early 1990s.
3. How did REITs hold up through COVID?
Kuhl: Through the pandemic initially, there was a lot of concern around rent collection. If you exclude retail, we saw around 95% rent collection** through the pandemic for all the other asset types. And as we sit today, we've even recovered in some of the more hard-hit sectors, like a retail from a rent collection perspective. The pandemic was interesting because although clearly it changed many aspects of everyone's life, it actually didn't change all that much in terms of the long-term trends that were already in place for commercial real estate. You know, a big one of those would be the proliferation of eCommerce and retail real estate has become in our view, impaired in many cases and something like warehouse logistics real estate has become much more valuable.
How are REITs positioned as economies reopen?
Greenberger: REITs are operating in a position of strength given their balance sheet strength coupled with their operational capabilities that will allow them to take advantage of opportunities that might arise during a reopen (of the economy). This could include developing properties where that makes sense and where pre-leasing exists, which can be very earnings and creative for underlying investors. It could also mean issuing equity and debt to grow through acquisitions and refurbishment or redevelopment of existing properties.
4. Why is now an interesting time to invest in REITs?
Kuhl: It's an interesting time to invest in REITs as an asset class because we're still seeing innovation and growth from some existing property types that have been around for a long time like industrial/logistics, for instance. That's something that has sort of entered a new phase of growth that is readily accessible via the listed REIT market more so than other types of ownership. And we also see lots of new property types, today we have cold storage REITs, we have gaming REITs, we have age-restricted manufactured housing REITs, we have lab space REITs. A lot of these property types didn't exist in the public market going back several years. So the ability to participate in the growth of some of those is really exciting.
*Nareit, S&P Global Market Intelligence, REIT Dividend Growth per Share vs. Consumer Price Index. Past performance is not a guide to future performance.
**FTSE EPRA NAREIT North America Index rent collection through April and May 2020. The index is designed to track the performance of listed real estate companies and REITs in North American markets (U.S. and Canada).
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