Cornell University’s Baker Program in Real Estate and Hodes Weill & Associates recently published their 11th annual Institutional Real Estate Allocations Monitor. For the first time the survey included a set of drilldown questions assessing how institutions are using REITs in their portfolios.
The survey found that institutions “consider REITs to be a complement to private real estate in overall portfolios in terms of filling allocation needs and addressing liquidity objectives.” Overall, 84% of institutions that actively invest in REITs consider it part of their real estate allocation (rather part of their equities bucket). The survey also found that 42% of institutions were planning to make investments in REITs in 2023.
Meanwhile, another new study by CEM Benchmarking Inc. looked at defined benefit plans. It found that REITs outperform private real estate by nearly 2.3%. The study, which is commissioned by Nareit on an annual basis, “spans more than two decades and includes data from the dot-com crash, 2008 Global Financial Crisis, and the COVID-19 pandemic.”
The research comes amid what has been a mixed year for publicly-traded REITs. Year-to-date the FTSE Nareit All Equity REITs index was down 8.56% as of the end of October. The FTSE Nareit Equity REITs index, meanwhile, was down 6.41%. That puts REITs slightly below The Russell 2000, which was down 4.45% during the same period.
However, REITs have continued to report healthy fundamentals, with an early read on third quarter results showing that REITs continue to boast healthy balance sheets.
WealthManagement.com spoke with Edward F. Pierzak, Nareit senior vice president of research, and John Worth, Nareit executive vice president for research and investor outreach, about the reports.
This interview has been edited for style, length and clarity.
WealthManagement.com: Let’s start with the Hodes Weill report. What jumped out at you with their findings?
John Worth: It’s an impressive scope in terms of the respondents they get. It’s based on data from 175 investors in 25 countries with a total AUM of $10 trillion with over $1 trillion invested in real estate. It’s a quality sample of institutional investors. One of their innovations this year was adding a couple of questions about REITs.
The results were quite interesting. For U.S. institutions, 43% are using REITs as part of their real estate strategy. If they look at the subset of the largest and most sophisticated institutions, that number jumps to 65%. We have looked before at the 25 largest real estate investors and came up with very consistent numbers. It reaffirms this notion that a significant share of the largest, most sophisticated institutions are using REITs and managing them as part of their real estate allocation. Overall, 84% include REITs as part of their real estate allocation as opposed to their public equities allocation.
What’s most striking in a “man bites dog” way is that it’s the smaller institutions that aren’t using REITs. You would think the smaller you are, it would be simpler to do a sleeve of REITs as part of their real estate allocation. But instead that’s where we see a lower uptake.
WealthManagement.com: In some of our past conversations you’ve talked about institutions using REITs as part of a “completion” strategy to perhaps complement their existing portfolios to again access to property types or geographies they may not have exposure to. Does this research align with that concept?
John Worth: They asked the question in the survey, “What are the reasons you’re using REITs?” Overall, 26% say they are using REITs to access certain sectors and strategies. In addition, 38% say it’s part of their core real estate strategy. And 46% are saying it’s playing a role in providing liquidity in their real estate strategy. And 10% are using REITs to access international markets. That’s another flavor of that completion strategy. They can use REITs to get into sectors or international markets. We’re seeing that scope and the lists we have on our Powerpoints and seeing those reasons reflected in what the users are saying.
The piece that jumped out to me was in the greater than $50 billion cohort, 43% are using REITs to access specific sectors vs. 16% of respondents with less than $50 billion in assets. The completion strategy is mapping to the largest, most sophisticated investors. They are on the leading edge of that.
WealthManagement.com: In this space, do you often see smaller institutions follow the investment strategies of larger institutions? In other words, seeing these numbers, could we expect to see the smaller institutions adapting their use of REITs going forward?
John Worth: You would expect it. It is one of reasons we have undertaken the process to get larger, innovative investors to do testimonials and write guest pieces on our blog and come on our podcast. We want to get that message out of what they are finding effective. REITs can be an effective solution. Our hope is that over time as the testimonials get out, we will see more of that thought leadership spread through the industry.
WealthManagement.com: What about even individual investors? Are there potentially lessons for them here?
John Worth: My view is that there are lessons for institutions from individuals. Individuals have “listed real estate first” approach. Individuals are getting access thorough active and passive REIT funds. They have a lesson for pensions.
WealthManagement.com: Pivoting to the CEM study, this is an annual piece you do. What are the top takeaways from what you are looking at with defined benefit plans?
John Worth: We are up to 24 years of data. What is central to this study is that they are able to look at the performance across asset classes. It’s not based on index returns, but instead on the lived experiences of pension funds. It’s helpful for pension funds in that this is what they and their peers are experiencing.
REITs perform very well. They are the second best asset class on a net return basis over the 24-year period. They meaningfully outperform unlisted real estate by 2.3% over the full scope of this period. CEM is also able to get down to the real estate style and look at how REITs do vs internally-managed real estate managed by pensions, core funds and funds of funds. Irrespective of the style, REITs ourtperform. The closest comparison is to internally-managed direct real estate. But that’s only done by the very largest pension funds. There’s a very select group that can do that in a select group of property types.
And since CEM is not dealing with index return and is seeing individual pension fund returns, it can de-lag data and look at different assets over a consistent time period. So it’s apples to apples. Once you have gotten rid of the time lag, the correlation between public and private is 0.9. It’s all real estate. It’s got the same fundamental drivers. So, not surprisingly, once you get rid of the time lag, they are highly correlated. However, REITs meaningfully outperform on a risk-adjusted basis.
WealthManagement.com: Is there anything that’s different with this year’s findings or is this consistent with what you have found in doing this study in past years?
John Worth: It’s very consistent with what we have seen in prior years. The degree to which REITs outperform moves up and down year to year, but it’s always somewhere in the 2% range. It’s also very consistent in other academic research and other literature. The data has real stability to it.
WealthManagement.com: We’re nearly in mid-November, but can you talk briefly about October’s results?
Ed Pierzak: The all-equity index was down a little more than 3%. If you do a comparison with the Russell 2000, that was down not quite 3%. REITs underperformed, but were in the same ballpark. The relative underperformance for REITs is what you often see in a monetary policy tightening cycle. Typically once the cycles are complete, we often see that not only do REIT returns bounce back, but they tend to outperform equities and private real estate. As we look at performance so far in the beginning of November, we may be seeing that falling into place a bit.
WealthManagement.com: And it seems like we may be at the end of the tightening cycle, correct?
Ed Pierzak: With the pause in September and the pause in October/November, there’s a sense things may be done. We’ll know for a fact once we get to December. But it feels as if we are at or near the end of the current tightening cycle.
WealthManagement.com: You will also publish the next T-Tracker soon. Can you give us a preview of that?
Ed Pierzak: We see a continuation of the trends that we have seen in the past. In terms of operational performance, FFO and same-store NOI are both positive. From quarter to quarter, it’s been waning a bit, but that’s to be expected. In terms of balance sheets, REITs are in great shape. Overall leverage ratios are still around 35%. The average term to maturity is 6.5 years. They have plenty of duration to get through it. And average cost of debt remains low at around 4%. And fixed-rate debt accounts for more than 90% of REIT debt. Unsecured debt is almost 80%. REITs have been exercising good discipline in managing their balance sheets.
