Introducing the REITs 3.0 flywheel
Global Property Equities portfolio manager Greg Kuhl discusses the concept of the REITs 3.0 flywheel and how its virtuous cycle of sustainable growth can generate value for investors.
Key takeaways
- Leading listed REITs possess dominant market scale, operational expertise, and continuous access to capital, which feed into the flywheel concept, creating value and helping to generate attractive long-term returns for investors.
- Identifying REITs that are either already taking advantage of the flywheel, or can do so in the near future is a key aspect of a successful investment process.
In our earlier article, ‘Investing in the future with REITs 3.0’ we talked about how real estate investment trusts (REITs) have evolved into an asset class very much relevant today and beyond. Here, we introduce the REITS 3.0 flywheel of value creation.
The concept of a ‘flywheel effect’ in business was popularised by Jim Collins in his 2001 book ‘Good to Great’ and is based around the idea that a series of small steps, rather than a sudden breakthrough, can accumulate to create growing momentum and a virtuous cycle of sustainable growth. The idea has been explicitly used by a wide range of companies and institutions, perhaps most famously by Jeff Bezos as he sketched out Amazon’s long-term growth strategy in the early 2000s.
REITs 3.0: flywheel of value creation
1 Alexander Beath and Chris Flynn: Asset Allocation and Fund Performance of Defined Benefit Pension Funds in the United States, 1998-2018. 10.2% for listed REITs versus 7.5% for unlisted real estate.
2 Thomas Arnold, David Ling, and Andy Naranjo, Private Equity Real Estate Fund Performance: A Comparison to Listed REITs and Open-End Core Funds, June 2021, forthcoming in the Journal of Portfolio Management.
Armed with dominant market scale, industry-leading operational expertise, and continuous access to capital, we believe that leading listed REITs can, and do, use the flywheel concept to help generate compelling returns that compound value to shareholders on a long-term basis. In our view, many publicly-traded REITs are uniquely positioned to implement this concept in a way that would be very difficult to achieve in other forms of real estate ownership.
There are two main reasons for this:
First, listed REITs, like all publicly-traded companies, are designed to be perpetual vehicles, ie. to manage capital over an unlimited time horizon. As such, they have the ability and the economic incentive to make investments today that can generate returns long into the future, which accrue equally to all shareholders. Some examples of this include investments in technologies used in the property sector (aka PropTech) and its integration to support gradual evolution in operational proficiency, or the development of a corporate structure capable of supporting a scale of asset ownership and management well beyond what exists at present. A traditional private real estate fund with a predetermined life of perhaps seven years, after which assets are sold and capital is returned to investors (non-perpetual vehicle), may lack the time horizon to justify or fully implement and benefit from such investments.
Leading commercial real estate companies are leveraging on an array of technology platforms and offerings
Source: Altus Group, BMO Capital Markets: PropTech the Next Frontier in Commercial Real Estate, June 2021.
Second, listed REITs’ continuous access to permanent capital afforded by the public equity markets is highly conducive to the gradual stairstep-like progress embodied in the flywheel construct. The ability to raise equity in response to attractive investment opportunities and “match fund” this growth is a crucial element of the flywheel process. “Match funding” means a REIT is able to pay for an acquisition using the same mix of debt and equity already present in its capital structure. This ability to raise equity at any time as part of the “match funding” process is a unique advantage for listed REITs. This cadence of investment and capital raising is often the opposite of the traditional private real estate fund model, where the capital is raised first during a discrete (often 12-18 month) commitment period, and then must be deployed into available opportunities. The fact that listed REITs are not constrained by commitment and deployment periods allows them to be truly opportunistic in allocating capital. In addition, the stock market can act like a voting machine, which often benefits the best operators. Listed REITs that successfully execute on the various elements of the flywheel may see more demand from investors to buy their stock, typically resulting in higher share prices over time. As the market-determined share price of a listed REIT increases, so does its buying power and the returns it can generate from “match funded” investments.
Not every listed REIT is executing on the REITs 3.0 flywheel, but in our view, those that do are well placed to deliver long-term outperformance. Identifying those REITs that are either already taking advantage of the flywheel, or can do so in the near future is a key aspect of a successful investment process.
In future posts, we will explore in greater detail, some of the key components driving the REITs 3.0 flywheel.
These are the views of the author at the time of publication and may differ from the views of other individuals/teams at Janus Henderson Investors. Any securities, funds, sectors and indices mentioned within this article do not constitute or form part of any offer or solicitation to buy or sell them.
Past performance does not predict future returns. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.
The information in this article does not qualify as an investment recommendation.
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Important information
Please read the following important information regarding funds related to this article.
- Shares/Units can lose value rapidly, and typically involve higher risks than bonds or money market instruments. The value of your investment may fall as a result.
- The Fund is focused towards particular industries or investment themes and may be heavily impacted by factors such as changes in government regulation, increased price competition, technological advancements and other adverse events.
- This Fund may have a particularly concentrated portfolio relative to its investment universe or other funds in its sector. An adverse event impacting even a small number of holdings could create significant volatility or losses for the Fund.
- The Fund invests in real estate investment trusts (REITs) and other companies or funds engaged in property investment, which involve risks above those associated with investing directly in property. In particular, REITs may be subject to less strict regulation than the Fund itself and may experience greater volatility than their underlying assets.
- The Fund may use derivatives with the aim of reducing risk or managing the portfolio more efficiently. However this introduces other risks, in particular, that a derivative counterparty may not meet its contractual obligations.
- If the Fund holds assets in currencies other than the base currency of the Fund, or you invest in a share/unit class of a different currency to the Fund (unless hedged, i.e. mitigated by taking an offsetting position in a related security), the value of your investment may be impacted by changes in exchange rates.
- When the Fund, or a share/unit class, seeks to mitigate exchange rate movements of a currency relative to the base currency (hedge), the hedging strategy itself may positively or negatively impact the value of the Fund due to differences in short-term interest rates between the currencies.
- Securities within the Fund could become hard to value or to sell at a desired time and price, especially in extreme market conditions when asset prices may be falling, increasing the risk of investment losses.
- Some or all of the ongoing charges may be taken from capital, which may erode capital or reduce potential for capital growth.
- The Fund could lose money if a counterparty with which the Fund trades becomes unwilling or unable to meet its obligations, or as a result of failure or delay in operational processes or the failure of a third party provider.
- In addition to income, this share class may distribute realised and unrealised capital gains and original capital invested. Fees, charges and expenses are also deducted from capital. Both factors may result in capital erosion and reduced potential for capital growth. Investors should also note that distributions of this nature may be treated (and taxable) as income depending on local tax legislation.
Specific risks
- Shares/Units can lose value rapidly, and typically involve higher risks than bonds or money market instruments. The value of your investment may fall as a result.
- Shares of small and mid-size companies can be more volatile than shares of larger companies, and at times it may be difficult to value or to sell shares at desired times and prices, increasing the risk of losses.
- If a Fund has a high exposure to a particular country or geographical region it carries a higher level of risk than a Fund which is more broadly diversified.
- The Fund is focused towards particular industries or investment themes and may be heavily impacted by factors such as changes in government regulation, increased price competition, technological advancements and other adverse events.
- This Fund may have a particularly concentrated portfolio relative to its investment universe or other funds in its sector. An adverse event impacting even a small number of holdings could create significant volatility or losses for the Fund.
- The Fund invests in real estate investment trusts (REITs) and other companies or funds engaged in property investment, which involve risks above those associated with investing directly in property. In particular, REITs may be subject to less strict regulation than the Fund itself and may experience greater volatility than their underlying assets.
- The Fund may use derivatives with the aim of reducing risk or managing the portfolio more efficiently. However this introduces other risks, in particular, that a derivative counterparty may not meet its contractual obligations.
- If the Fund holds assets in currencies other than the base currency of the Fund, or you invest in a share/unit class of a different currency to the Fund (unless hedged, i.e. mitigated by taking an offsetting position in a related security), the value of your investment may be impacted by changes in exchange rates.
- When the Fund, or a share/unit class, seeks to mitigate exchange rate movements of a currency relative to the base currency (hedge), the hedging strategy itself may positively or negatively impact the value of the Fund due to differences in short-term interest rates between the currencies.
- Securities within the Fund could become hard to value or to sell at a desired time and price, especially in extreme market conditions when asset prices may be falling, increasing the risk of investment losses.
- Some or all of the ongoing charges may be taken from capital, which may erode capital or reduce potential for capital growth.
- The Fund could lose money if a counterparty with which the Fund trades becomes unwilling or unable to meet its obligations, or as a result of failure or delay in operational processes or the failure of a third party provider.
Specific risks
- Shares/Units can lose value rapidly, and typically involve higher risks than bonds or money market instruments. The value of your investment may fall as a result.
- Shares of small and mid-size companies can be more volatile than shares of larger companies, and at times it may be difficult to value or to sell shares at desired times and prices, increasing the risk of losses.
- If a Fund has a high exposure to a particular country or geographical region it carries a higher level of risk than a Fund which is more broadly diversified.
- The Fund is focused towards particular industries or investment themes and may be heavily impacted by factors such as changes in government regulation, increased price competition, technological advancements and other adverse events.
- This Fund may have a particularly concentrated portfolio relative to its investment universe or other funds in its sector. An adverse event impacting even a small number of holdings could create significant volatility or losses for the Fund.
- The Fund invests in real estate investment trusts (REITs) and other companies or funds engaged in property investment, which involve risks above those associated with investing directly in property. In particular, REITs may be subject to less strict regulation than the Fund itself and may experience greater volatility than their underlying assets.
- The Fund may use derivatives with the aim of reducing risk or managing the portfolio more efficiently. However this introduces other risks, in particular, that a derivative counterparty may not meet its contractual obligations.
- If the Fund holds assets in currencies other than the base currency of the Fund, or you invest in a share/unit class of a different currency to the Fund (unless hedged, i.e. mitigated by taking an offsetting position in a related security), the value of your investment may be impacted by changes in exchange rates.
- When the Fund, or a share/unit class, seeks to mitigate exchange rate movements of a currency relative to the base currency (hedge), the hedging strategy itself may positively or negatively impact the value of the Fund due to differences in short-term interest rates between the currencies.
- Securities within the Fund could become hard to value or to sell at a desired time and price, especially in extreme market conditions when asset prices may be falling, increasing the risk of investment losses.
- The Fund may incur a higher level of transaction costs as a result of investing in less actively traded or less developed markets compared to a fund that invests in more active/developed markets. These transaction costs are in addition to the Fund's Ongoing Charges.
- Some or all of the ongoing charges may be taken from capital, which may erode capital or reduce potential for capital growth.
- The Fund could lose money if a counterparty with which the Fund trades becomes unwilling or unable to meet its obligations, or as a result of failure or delay in operational processes or the failure of a third party provider.
- In addition to income, this share class may distribute realised and unrealised capital gains and original capital invested. Fees, charges and expenses are also deducted from capital. Both factors may result in capital erosion and reduced potential for capital growth. Investors should also note that distributions of this nature may be treated (and taxable) as income depending on local tax legislation.
Specific risks
- Shares/Units can lose value rapidly, and typically involve higher risks than bonds or money market instruments. The value of your investment may fall as a result.
- Shares of small and mid-size companies can be more volatile than shares of larger companies, and at times it may be difficult to value or to sell shares at desired times and prices, increasing the risk of losses.
- The Fund is focused towards particular industries or investment themes and may be heavily impacted by factors such as changes in government regulation, increased price competition, technological advancements and other adverse events.
- The Fund invests in real estate investment trusts (REITs) and other companies or funds engaged in property investment, which involve risks above those associated with investing directly in property. In particular, REITs may be subject to less strict regulation than the Fund itself and may experience greater volatility than their underlying assets.
- The Fund may use derivatives to help achieve its investment objective. This can result in leverage (higher levels of debt), which can magnify an investment outcome. Gains or losses to the Fund may therefore be greater than the cost of the derivative. Derivatives also introduce other risks, in particular, that a derivative counterparty may not meet its contractual obligations.
- If the Fund holds assets in currencies other than the base currency of the Fund, or you invest in a share/unit class of a different currency to the Fund (unless hedged, i.e. mitigated by taking an offsetting position in a related security), the value of your investment may be impacted by changes in exchange rates.
- When the Fund, or a share/unit class, seeks to mitigate exchange rate movements of a currency relative to the base currency (hedge), the hedging strategy itself may positively or negatively impact the value of the Fund due to differences in short-term interest rates between the currencies.
- Securities within the Fund could become hard to value or to sell at a desired time and price, especially in extreme market conditions when asset prices may be falling, increasing the risk of investment losses.
- Some or all of the ongoing charges may be taken from capital, which may erode capital or reduce potential for capital growth.
- The Fund could lose money if a counterparty with which the Fund trades becomes unwilling or unable to meet its obligations, or as a result of failure or delay in operational processes or the failure of a third party provider.
- In addition to income, this share class may distribute realised and unrealised capital gains and original capital invested. Fees, charges and expenses are also deducted from capital. Both factors may result in capital erosion and reduced potential for capital growth. Investors should also note that distributions of this nature may be treated (and taxable) as income depending on local tax legislation.