REITs: Liquid Real Estate Exposure

The growing sector has become the bellwether for the U.S. real estate market, providing transparent and regularized data in an otherwise opaque market.

REIT 101

REITs are investment vehicles offering exposure to a variety of real estate sectors and markets. They are corporate entities that own and develop real estate. The REIT structure can avoid corporate taxation by passing at least 90% of taxable income to shareholders. This article addresses only publicly traded REITs, although some REITs are privately traded.

U.S. REITs are traded largely on the New York Stock Exchange (NYSE) as either 1) equity REITs (more than 90% of the sector) that own, develop and operate properties, and 2) mortgage REITs that lend money to owners and developers of real estate.

Growth: From Niche to S&P

REITs have existed for more than 50 years, but the market was small until the 1990s. Originally designed in the 1960s as passive, mutual fund-like vehicles, tax reforms in the 1990s allowed REITs to take more active ownership roles in properties.

The market has grown from roughly 50 REITs in the 1990s with a $5 billion market cap to 183 publicly-traded REITs with a $1.3 trillion market cap. In 2016, REITs became the 11th category in the S&P 500, cementing their broad acceptance.

Real Estate Investment Trusts (REITs)

This article clarifies the REIT structure and market and how they can make real estate investments more liquid.

Overview

The $1.3 trillion U.S. REIT market has grown considerably following regulatory changes in the 1990s.

The publicly traded nature of REITs, the quality of the real estate and the size of the holdings have made REITs attractive targets for mergers and acquisitions (M&A) and arbitrage for pricing differentials between public and private real estate markets.

REITs have outperformed the S&P 500 over several time frames and broadly over 30 years.

Conclusions

REITs offer attractive long-term returns, diversification and quality, sector allocation and an inflation hedge.

REIT pricing has rebounded in recent years. The Family Office continues to track the sector and utilizes the deep pool of REIT research information to support real estate sector and market decisions and identify dislocation in public and private markets.

Benefits of Ownership

Attractive Long-Term Returns: The charts overleaf show the impressive track record of REITs over the last 30 years.

Enhanced Diversification and Quality: REITs provide “ownership” of real estate in numerous geographies, property types, risk categories and lease durations. Assets owned or developed by REITs are typically Class-A with low leverage.

Sector Allocation: REITs can provide high-quality assets and management teams in niche real estate sectors or markets (i.e. data centers, self-storage, healthcare, or gateway markets) where entry would otherwise be restricted to the largest investors.

Inflation Hedge: The underlying rent-based lease revenues of many REITs reprice periodically, providing attractive hedges to inflation.

Consolidation and Opportunities

REITs are traditionally large portfolios of quality real estate assets with a similar location or profile. As publicly traded vehicles, REITs have undergone increasing M&A activity. In the last three to four years, the handful of real estate investors dominating the large fund-raising market ($10 billion and above) have made multi-billion dollar acquisitions in the space including: the $15 billion acquisition of GGP (mall REIT) and the $7 billion acquisition of Forest City (residential/ retail REIT) by Brookfield in 2018, and the $13 billion acquisition of Liberty Property Trust and the $9 billion acquisition of DCT Industrial Trust (both industrial REITs) by ProLogis in 2018 and 2019, respectively.

Arbitrage opportunities arise in times of dislocation, where REITs may be mispriced relative to private real estate valuations and vice versa. Based on the industry-leading research provider GreenStreet, valuations are aligned fairly, with the private markets earning a 0.70% higher expected return than the public market, while REITs remain on the higher end of the “fair” pricing designation but not yet “pricey.”

Risks

REITs offer several attractive advantages as a proxy for direct ownership of real estate, but the liquid nature of the asset class presents risks that include linkage to the general equity market cyclicality, negative correlation to interest rate increases, and potential tax implications in respect of dividends and capital gains.

Performance: Strong Index Growth and Varied by Property Sector

Sector YTD 2019 Performance (Total Return)

Outlook

With high domestic and foreign demand for real estate and the acceptance of REITs by institutional and individual equity traders, REITs continue to provide attractive risk-adjusted returns across a broad sector of real estate.