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