A BASKET OF REITS According to Kirby and Barden
Gale, vice chairman-real estate with Star wood Capital, pension
funds often have minimized their real estate allocations to REIT
stocks in preference to direct ownership or privately owned real
estate funds—which, historically speaking, haven’t matched the
returns of REITs.
Ted Bigman, managing director and Morgan Stanley’s global
head of real estate, agrees that REIT stocks have an important place in any pension fund’s portfolio. “Most sophisticated
analyses illustrate that an investment in both domestic and
global listed property companies is additive to a multi-asset class
portfolio,” he says.
“REITs definitely have a place in a portfolio, especially when
you look at performance of REITs over time, compared with
other indexes and direct ownership of real estate,” notes Constance B. Moore, president and CEO of BRE Properties Inc
(NYSE: BRE). “A basket of REITs in your portfolio allows
investors to diversify more quickly, both geographically and
by property type. They can go heavy or light in different areas,
according to their understanding of the markets. With REIT
stocks, a portfolio manager can be very selective.”
STRENGTH IN NUMBERS Research shows that
investing in REITs is tantamount to investing in real estate. “Real
estate securities represent an asset class distinct from bonds and
other stocks in most countries,” Peter Westerheide of the Center for
European Research wrote in 2006. “In the long run, they seem to
reflect the performance of direct real estate investments and provide
a potential for further diversification of asset portfolios.”
Moreover, long-term correlation between the returns from equity
REITs and the returns from other U.S. equities is only approximately
40 percent, meaning that only 40 percent of the variance of REIT
returns can be explained by the movements in the stock market. The
major part of REIT variance comes from other factors, such as the
timing of economic conditions on new construction, vacancies and
rent growth that more directly affect the real estate market.
In short, REITs provide an effective vehicle for portfolio diversification. But what about returns?
COMPETITIVE PERFORMANCE Total returns
make the story even more compelling. An investment of $100
million in equity REITs 30 years ago would have been worth
more than $2.66 billion by the end of November 2008. Even
taking into account the decline of the REIT market in October
and November 2008, compounded growth rate of 11.56 percent
per year outperformed the Standard & Poor’s 500, which grew by
11.01 percent over the same period. Institutional core real estate
tallied 10 percent per year growth over the decades according to
data complied by the National Council of Real Estate Investment
Fiduciaries, which is before taking into account the current decline
is property values, which hasn’t shown up in NCREIF’s total return
estimates yet.
While some of the outperformance by REITs relative to the
NCREIF Property Index (NPI) can be attributed to its presentation of property-level returns after the effect of leverage has been
removed, REIT returns exceeded NCREIF Property Index returns
after adjusting for leverage and other factors. No fewer than three
separate research studies covering periods extending from 1980 to
2005 bore out this conclusion, with equity REITs averaging adjusted
returns of 11. 3 percent annually while the NCREIF Property Index
averaged 8. 4 percent.
Another investment consideration for pension funds, or for any
investor, is the fee structure associated with each asset class. In that
regard, REITs generally come out ahead.
Data culled from private offering memoranda and other sources
show that third-party management fees associated with REITs average about 50 basis points, or 3 percent to 4 percent of total returns.
This is modest compared with institutional core real estate funds
with fees averaging 110 basis points ( 11 percent of total returns)
according to NCREIF. Fees associated with other core property
investments are not easily available, but they appear to average annual 110 basis points as well. REIT fees also are a bargain when
compared with opportunity funds, which can cost investors as much
as 180 to 780 basis points, amounting to 11 percent to 28 percent of
implied target gross return.
Over the last two years, REIT stocks have been trading at a 10. 5
percent discount to net asset value, a positive circumstance for investors looking to invest in real estate securities. “REIT data since 1990
suggest large positive excess returns to a strategy of buying stocks
that trade at a discount to NAV, and shorting stocks trading at a
premium to NAV,” wrote William M. Gentry, Charles M. Jones and
Christopher J. Mayer in the study “REIT Reversion: Stock Price
Adjustments to Fundamental Value” in 2004.
For the last 13 years, Green Street Advisors found investors who
increased REIT allocations when NAV discounts were the norm
and decreased REIT allocations when REITs were trading at sizable
premiums have reaped excess returns.
If REIT stocks offer better long-term returns at lower cost, why
do pension funds on the whole allocate such small percentages of
their real estate holdings to REITs? A number of factors seem to
be at work.
For one thing, pension funds have a longer history with direct
investment in real estate. Even as recently as the earlier part of the
decade, pension funds saw REITs as a growing, but still relatively
small, universe of stocks, notes BRE’s Moore.
“REITs are under-represented in portfolios, in part because public
real estate is still relatively new as an asset class and still fairly small,”
says Marc R. Halle, a managing director for Prudential Real Estate
Investors. “There’s $17 trillion to $20 trillion in total real estate in
the world today, and publicly traded real estate companies worldwide only hold approximately $1 trillion of that, or approximately
5 percent.
