For financial professionals in Italy

Investing in the future with REITs 3.0

Greg Kuhl, CFA

Greg Kuhl, CFA

Portfolio Manager


1 Oct 2021

Portfolio manager Greg Kuhl provides an overview of how REITs have evolved since first created sixty years ago to being an asset class very much relevant today and beyond.

Key takeaways

  • The first REIT was established in the US in 1960 as a means for individual investors to access the benefits of commercial real estate ownership.
  • Since then, REITs have evolved to become companies with formidable scale, operational excellence and continuous access to capital, with the potential to offer investors a new level of compounding growth.

Although it may not seem like it, listed real estate investment trusts (REITs), as we know them today, form a relatively young asset class that is still gaining acceptance with investors. In this and a series of posts to follow, focusing on US REITs being the largest and most established property market, we discuss the development of the asset class and, more importantly, what may be in store for its future.

To start, a brief review of REIT history is helpful. We have condensed this into three distinct periods, which we refer to as REITs 1.0, REITs 2.0, and REITs 3.0.

REITs: a brief history

REITs history timeline REITs 3.0

Source: Janus Henderson Investors, National Association of Real Estate Investment Trusts (NAREIT) as at 30 September 2021.

REITs 1.0: 1960-1990

US REIT Rules were established in 1960 to allow individual investors access to the benefits of commercial real estate ownership. REITs brought liquidity1 to a previously illiquid asset class by being tradeable on stock exchanges, while offering tax efficiency2 and exposure to high-quality property for investors. The first REIT listed on the New York Stock Exchange (NYSE) in 1965. Most early REITs invested in commercial mortgages rather than in the ownership of buildings. They were typically run with high levels of financial leverage3 and ‘externally managed’, meaning their executives were not employees of the REIT and instead collected a management fee for allocating the REITs capital (a relationship fraught with conflicts of interest that generally does not exist in US-listed REITs today). In many ways, several of these early vehicles were more akin to banks or specialised lenders than actual owners of real estate.

REITs 2.0: 1991 – 2015

The 1991 initial public offering (IPO) of Kimco Realty Corporation (KIM), a shopping center REIT, is widely regarded as the first successful IPO, heralding the start of the ‘modern REIT era.’ Also, in 1991, the US REIT industry trade body – National Association of Real Estate Investment Trusts (NAREIT), defined Funds from Operations (FFO)4, which would become the primary cash flow metric reported by all listed REITs. FFO is widely recognised as a more accurate proxy for cash flows than earnings per share (EPS)5 derived from Generally Accepted Accounting Principles (GAAP)6 and likely helped lead to greater investor understanding of the real estate business. The 1990s saw the issuance of more than 150 REIT IPOs, taking the market capitalisation7 of the sector in the US from $16bn in 1992 to $138bn by the end of the decade. Many of these new listings consisted of private family-controlled real estate portfolios of relatively small breadth and scale, operating with high leverage.

The asset class continued to grow in scale and breadth while REIT regulations were further clarified and expanded during the latter half of the REITs 2.0 period. The Global Financial Crisis (GFC) dealt a major blow to many listed REITs that had been operating with high levels of financial leverage and poorly laddered debt8 maturity structures (weak risk management), though the vast majority survived after being refinanced with huge stock offerings at the expense of highly diluted shareholder equity. This post-GFC recapitalisation was a major turning point for the sector as it helped shape the capital structure deemed appropriate for a listed REIT. Today’s REITs typically operate with a much higher proportion of equity to debt than they used to pre-GFC, with much greater attention paid to the cadence of future debt maturities.

Bottom view of modern skyscrapers in business district at sunset with lens flare filter effect.

REITS 3.0: 2016 – present

In 2016, US REITs surpassed $1 trillion in market capitalisation and real estate was added as the 11th sector within the Global Industry Classification Standard (GICS)9. Until this point, real estate, including REITs were classified within the GICS financials sector along with banks and insurance companies. Importantly, the newly distinct sector significantly raised the profile of the asset class among investors and signaled its emergence as a more meaningful component of public markets.

Today the listed REIT industry features a vastly expanded array of property types, having evolved beyond the traditional core sectors such as retail, office, industrial and residential; increasingly investing in more diverse, non-core or emerging and growth-oriented sectors such as cell towers, data centres, self-storage and laboratory space. REITs now own and control market-leading portfolios, and benefit from powerful secular tailwinds such as e-commerce, cloud computing, 5G and changing demographics.

REITs: a dynamic and evolving asset class

REITs sector evolution 2

Source: NAREIT, FTSE, Janus Henderson Investors, as at 30 June 2021. The FTSE NAREIT All Equity REITs Index is a free-float adjusted, market capitalisation-weighted index of US equity REITs. Constituents of the index include all tax-qualified REITs with more than 50 percent of total assets in qualifying real estate assets other than mortgages secured by real property.

Many REIT companies possess formidable scale, are conservatively capitalised and highly sophisticated at accessing and deploying capital opportunistically. These large‑scale, operationally excellent companies, with continuous access to permanent capital, have the tools to potentially offer a new level of compounding growth to investors.

Next up…

In our next post, we discuss the concept of ‘REITS 3.0: flywheel of value creation,’ and how its various drivers are working in tandem to provide the tools to drive the long-term outperformance of REITs.

 

Footnotes:

1Liquidity: the ability to buy or sell a particular security or asset in the market. Assets that can be easily traded in the market (without causing a major price move) are referred to as ‘liquid’.

2REITs are considered to be tax efficient because in exchange for distributing approximately 90% or more of taxable income to shareholders, REITs gain tax-exempt status at the corporate level.

3Financial leverage: the use of borrowing to increase exposure to an asset/market. This can be done by borrowing cash and using it to buy an asset or by using financial instruments such as derivatives to simulate the effect of borrowing for further investment in assets

4FFO: Funds from Operations is a more accurate measure of REITs cash flow since it takes into account the depreciation expense, and therefore the ability for a REIT to maintain its dividends. Generally, FFO is calculated by taking the REIT's earnings and adding back the depreciation and amortisation of mortgages.

5Earnings per share (EPS): the portion of a company’s profit attributable to each share in the company. It is one of the most popular ways for investors to assess a company’s profitability. It is calculated by dividing profits (after tax) by the number of shares held.

6Generally Accepted Accounting Principles (GAAP): a common set of accounting principles, standards, and procedures. Publicly-listed companies must follow GAAP principles in their financial statements.

7Market capitalisation: the total market value of a company’s issued shares. It is calculated by multiplying the number of shares in issue by the current price of the shares. The figure is used to determine a company’s size, and is often abbreviated to ‘market cap’.

8Laddered debt: a portfolio of several smaller bonds with varying dates of maturity rather than one large bond with a single maturity date. The aim is to minimise interest rate risk, increase liquidity and diversify credit risk.

9GICS or Global Industry Classification Standard: widely used by investors, analysts and economists to define sectors of the public markets and classify companies into these sectors.

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.

 

Marketing Communication.

 

Glossary

 

 

 

Important information

Please read the following important information regarding funds related to this article.

The Janus Henderson Horizon Fund (the “Fund”) is a Luxembourg SICAV incorporated on 30 May 1985, managed by Henderson Management S.A. Henderson Management SA may decide to terminate the marketing arrangements of this Collective Investment Scheme in accordance with the appropriate regulation. This is a marketing communication. Please refer to the prospectus of the UCITS and to the KIID before making any final investment decisions.
    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.
  • 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'), the value of your investment may be impacted by changes in exchange rates.
  • When the Fund, or a hedged share/unit class, seeks to mitigate exchange rate movements of a currency relative to the base currency, the hedging strategy itself may create a positive or negative impact to 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.
The Janus Henderson Horizon Fund (the “Fund”) is a Luxembourg SICAV incorporated on 30 May 1985, managed by Henderson Management S.A. Henderson Management SA may decide to terminate the marketing arrangements of this Collective Investment Scheme in accordance with the appropriate regulation. This is a marketing communication. Please refer to the prospectus of the UCITS and to the KIID before making any final investment decisions.
    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.
  • 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'), the value of your investment may be impacted by changes in exchange rates.
  • When the Fund, or a hedged share/unit class, seeks to mitigate exchange rate movements of a currency relative to the base currency, the hedging strategy itself may create a positive or negative impact to 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.
The Janus Henderson Horizon Fund (the “Fund”) is a Luxembourg SICAV incorporated on 30 May 1985, managed by Henderson Management S.A. Henderson Management SA may decide to terminate the marketing arrangements of this Collective Investment Scheme in accordance with the appropriate regulation. This is a marketing communication. Please refer to the prospectus of the UCITS and to the KIID before making any final investment decisions.
    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.
  • 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'), the value of your investment may be impacted by changes in exchange rates.
  • When the Fund, or a hedged share/unit class, seeks to mitigate exchange rate movements of a currency relative to the base currency, the hedging strategy itself may create a positive or negative impact to 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.
Janus Henderson Capital Funds Plc is a UCITS established under Irish law, with segregated liability between funds. Investors are warned that they should only make their investments based on the most recent Prospectus which contains information about fees, expenses and risks, which is available from all distributors and paying/facilities agents, it should be read carefully. This is a marketing communication. Please refer to the prospectus of the UCITS and to the KIID before making any final investment decisions. The rate of return may vary and the principal value of an investment will fluctuate due to market and foreign exchange movements. Shares, if redeemed, may be worth more or less than their original cost. This is not a solicitation for the sale of shares and nothing herein is intended to amount to investment advice. Henderson Management SA may decide to terminate the marketing arrangements of this Collective Investment Scheme in accordance with the appropriate regulation.
    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 towards the aim of achieving its investment objective. This can result in 'leverage', which can magnify an investment outcome and gains or losses to the Fund may 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'), the value of your investment may be impacted by changes in exchange rates.
  • When the Fund, or a hedged share/unit class, seeks to mitigate exchange rate movements of a currency relative to the base currency, the hedging strategy itself may create a positive or negative impact to 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.