‘Real Matters’ provides the latest insights and thoughts from the Janus Henderson Global Property Equities Team. In the third article in the series, Tim Gibson and Guy Barnard, Co-Heads of Global Property Equities, discuss the recent performance of REITs and the diversification benefits they can provide.
The answer predominantly, is: “Better than all the rest”!
Since the end of September 2018, global real estate investment trusts (REITs) are up 3.2% versus the MSCI World Equities Index’s fall of 8.5%1.
But where do we go from here and what role can listed real estate play for investors?
“Don't look back in anger”: how did 2018 end up for global real estate?
The FTSE EPRA NAREIT Developed Index fell by 5.6% in 20182. While the absolute numbers may not have overwhelmed, REITs provided valuable diversification benefits to clients, having hit their low for the year in February. They subsequently made modest gains as global growth and reflation expectations unwound and investors sought more defensive, resilient income streams. We expect this trend to continue given greater levels of macro-economic uncertainty and increased volatility in capital markets, such as we saw in 2018.
US Stock Market Volatility
Source: Thomson Reuters Datastream, S&P 500 Price Index, 31 December 2016 to 31 December 2018. Past performance is not a guide to future performance.
“Another brick in the wall”: diversification, diversification, diversification.
The old adage ‘location, location, location’ is certainly true when it comes to property but diversification is also a key benefit of REITs.
Global REITs offer equity risk diversification as well as regional diversification, with a geographical split of approximately 50% North America, 30% Asia Pacific and 20% in Europe. This geographic dispersion helps diversify macro risks, including economic conditions, central bank monetary policy and political factors. Real estate is ultimately a highly localised business, with property types, cities and countries operating at varying points in the property cycle. Geographic diversity therefore provides actively managed funds with a larger opportunity set from which to choose attractive investments.
While US REITs offer diversification benefits through lower correlations with broader equity markets, international REITs add another layer of diversification benefit, with correspondingly lower correlation to US equities:
|S&P 500 correlation with...|
|North American REITs||0.75|
Source: S&P 500, FTSE EPRA NAREIT North America, Europe, and Asia indices, from 31/12/2005 to 30/09/2018. Past performance is not a guide to future performance.
REITs also have among the lowest sector correlations to technology – particularly during the dot-com peak and again more recently (see chart below) - offering a potential counterbalance to investors who are overweight in the technology sector.
Real Estate Equities correlation with Information Technology stocks and relative sector performance (on a rolling 3-year basis):
Source: Bloomberg, Janus Henderson Investors, as at 31 December 2018. Compares MSCI Real Estate and Information Technology sectors in USD. Red boxes indicate periods of low correlation during the dot-com peak and more recently. Past performance is not a guide to future performance.
“The times they are a-changin’”: what about interest rates and their impact on the sector?
After several years of relative underperformance versus the broader equity market and often hearing the push back that “REITs struggle in a rising interest rate environment” it now seems likely that the interest rate cycle is peaking in the US - this should be positive for REITs.
Moreover, the misconception that the sector is simply acting as a bond proxy is unfounded: the long-term correlation between real estate equities and government bonds is actually close to zero:
|Correlation 2010 - 2018||Global Sovereign Bonds||Global Corporate Bonds|
|Global Real Estate Equities||0.10||0.53|
|Correlation 1999 - 2018||Global Sovereign Bonds||Global Corporate Bonds|
|Global Real Estate Equities||0.01||0.48|
Source: FTSE EPRA Nareit Developed Index as proxy global index for listed real estate. ICE BofAML Global Corporate Index proxy for global corp. Bloomberg Barclays Global Treasury proxy for global sovereigns, 31/12/09 to 31/12/18 and 31/12/98 to 31/12/18. Past performance is not a guide to future performance.
In summary…“Life in the fast lane”?
REITs have provided valuable diversification and return enhancement to investors both recently and over the long term. While their performance cannot always be described as living “life in the fast lane” and may face challenges in a rising interest rate environment, at this point in the economic cycle, relatively defensive and predictable income-orientated companies may prove attractive to many investors.
1 source: Bloomberg, 28/09/18 to 29/01/19, total return in US dollars. Past performance is not a guide to future performance.
2 source: Bloomberg, 29/12/17 to 31/12/18, total return in US dollars. Past performance is not a guide to future performance.