For financial professionals in Italy

REITs 3.0: let’s talk about scale

Portfolio managers Greg Kuhl and Danny Greenberger examine the competitive advantages afforded by scale in the real estate investment trusts (REITs) sector.

Key takeaways:

  • The benefits of scale, from informational advantages, technology investments, and relationships with tenants offers a strong value proposition for REIT investors.
  • Long-standing relationships with local investment brokers and superior market intelligence enable REITs with scale to better source investment opportunities to meet tenants’ needs.
  • US REITs are the most developed, however many non-US leading REIT companies are also concentrating acquisitions and infusing technology into their operating platforms to create value for stakeholders.

In previous posts, we talked about how in the last decade, both the composition and quality of listed real estate has been changing for the better, making it a relevant investment today and in the future (REITs 3.0). Here we discuss the many benefits of scale, which offers competitive advantages for some leading REITs companies.

There are now 28 US real estate investment trusts (REITs) included in the S&P 500 Index, compared with 15 REITs in 20121, reflecting the depth and evolution of listed REITs exhibiting scale. Scale in property investments, derived from informational advantages, technology investments, and relationships with tenants and brokers, is worth exploring because of its value proposition for REIT owners, investors, and tenants.

Structural characteristics inherent to REITs – long-term stewardship by dedicated management teams coupled with relatively easy access to capital – has allowed some firms in the sector to build formidable positions of scale while investing over the long term to enhance the tenant experience and increase employee productivity. By being well positioned to deliver value for employees, tenants, and shareholders through these scale positions, REITs have furthered their competitive advantage in local sub-markets, which can result in REITs becoming favoured acquirers and developers of property assets.

Typical REIT scale benefits across property types

typical example of scale benefits of REITs

Source: Janus Henderson Investors as at 2 February 2022.

Performance incentivised advantage

Executives of listed REITs report to shareholder boards and are compensated to create shareholder value over both the short and longer term. REIT management teams also usually have significant equity in their businesses, incentivising long-term strategic decisions to build local market scale and leading operational capabilities.  REITs thus contrast with unlisted real estate vehicles (eg. non-traded REITs and open-ended funds) where investments are directed by investment advisors who are not employees of the funds in which they deploy capital; rather, these managers are ‘serial recyclers of capital’ who invest when capital has been raised and sell during fund harvesting cycles. As perpetual operating businesses with permanent capital (managed for an unlimited period), some REITs have methodically built positions of scale by concentrating capital in specific property types and geographies.

Notable examples of listed REITs with scale include:

  • The largest warehouse landlord, controlling over 1bn square feet globally
  • A single-family rental REIT that owns more than 80,000 homes with a concentration of almost 12,000 homes in just one metro area
  • A global data centre platform operating over 230 data centres on five continents for over 10,000 customers, supporting over 400,000 interconnections
  • The largest self-storage company with over 2200 total properties, with 213 and 130 stores in Los Angeles and San Francisco, respectively

Information advantage

Possessing scale in property offers a clear informational advantage. Those with a broader portfolio within a sub-market will have access to the most data and specialist information on factors like tenant traffic, leasing economics, and supply, meaning they are better informed about risks and opportunities compared to landlords with more limited holdings. Better information may Warehousetranslate to stronger asset performance as management teams are more equipped to make timely investment decisions. For example, they can respond quickly to fluctuating market conditions by adjusting asking rental rates or by adding or reducing exposure to certain markets. Given REITs typically have long-standing relationships with local investment brokers and superior market intelligence, those with scale are more likely to have an enviable platform to source investment opportunities to meet the specific needs of tenants.

Property and geographic specialisation advantage

As the REIT asset class evolves, the long-term orientation of REITs has led some leading companies across the sector to concentrate assets in specific property types and sub-markets (also known as ‘clustering’), fostering operational and competitive advantages and dominant local market positions. Clustering allows leasing agents and maintenance technicians to operate and provide services for assets within a sub-market that have similar requirements. For example, technicians can often repair equipment or service maintenance requests across more than one asset within a sub-market, thereby offering REITs a productivity boost to potentially support higher profit margins.

Tech advantage

As they tend to be well-capitalised owner-operators, many REITs have also invested in technology to optimise the operational performance of their assets. Within residential, ‘smart home’ hubs are providing digital entry and utilities control, resulting in cost savings for residents, as well as enabling self-guided touring for prospective residents.  Furthermore, the use of automated chat bots has allowed tenants to log service requests more efficiently, resulting in faster response times from maintenance personnel. These tech tools have concurrently often resulted in increased tenant satisfaction and higher employee productivity.

Strong growth prospects

Compared to property markets in other countries, the US REIT sector has the longest history and is the most mature and progressive, which has driven a higher absorption of US properties under REIT ownership, as assets should naturally flow to the firms with the highest productivity over time.

Although the REIT regime is less established outside of the US, many non-US leading REIT companies are also adopting a similar strategy of concentrating acquisitions and infusing technology into their operating platforms to create value for stakeholders. This complementary nature of scale and operating acumen seen across REITs underscores the sector’s formidable growth prospects moving forward.

Public-listed real estate by country

public listed real estate by country

Source: EPRA, UBS, Janus Henderson Investors analysis as at 31 October 2021.

Conclusion

2021 marked a stellar year of returns for REITs, with the FTSE EPRA NAREIT Developed Index in USD delivering more than 27% in total returns compared with 22% for global equities.2  With investor concerns about inflation and the prospects for higher interest rates, REITs may not repeat last year’s exemplary returns given past performance should not be considered as a guide to future returns, yet we remain encouraged by the sector’s focus on operating sophistication and alignment to drive value over the long term.

1 Source: NAREIT REITWatch, January 2022.

2 Source: Refinitiv Datastream. FTSE EPRA NAREIT Developed Index vs MSCI World Index, cumulative total returns in US dollar terms, 31 December 2020 to 31 December 2021. Past performance does not predict future returns. 

FTSE EPRA NAREIT Developed Index is designed to track the performance of listed real estate companies and REITs worldwide.

MSCI World Index captures large and mid-cap representation across 23 developed markets.

S&P 500® Index reflects US large-cap equity performance and represents broad US equity market performance.

Commercial real estate: property used only for business-related purposes (non-residential).

Open-ended fund: a collective investment that grows or shrinks in line with investor demand. New units are created when an investor buys/invest in the fund and units are cancelled when an investor sells their holding. The price of units is determined by the net asset value (NAV) of the underlying portfolio; the NAV will vary in line with portfolio performance in addition to investor inflows and outflows.

REIT: Real Estate Investment Trusts invest in real estate, through direct ownership of property assets, property shares or mortgages. As they are listed on a stock exchange, REITs are usually highly liquid and trade like shares.

Real estate securities, including Real Estate Investment Trusts (REITs) may be subject to additional risks, including interest rate, management, tax, economic, environmental and concentration risks.

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.