Pension Funds Are Buying REITs Hand Over Fist (2023)

Co-produced by Austin Rogers for High Yield Landlord

Pension funds have been increasing the portion of their investment portfolios invested in US real estate investment trusts ("REITs") (VNQ) in recent years. And during the pandemic over the past few years, they repositioned their REIT sectoral weightings in a big way.

Before we discuss the moves that pension funds are making in REITdom, we should note a few general points about the kinds of investors' pension funds are:

1. Pension funds are slow-moving behemoths that tend to trade infrequently and make portfolio adjustments as little as possible;
2. They are generally long-term buy-and-hold investors targeting steady total returns rather than quick pops of upside;
3. Pension funds are risk-averse and would rather settle for lower yet reliable returns than take greater risk in pursuit of higher returns.

You might be thinking, "Why should I care what pension funds are doing?"

Consider this. The "2022 Pension Real Estate Association Intentions Survey" ("PREA") found that though pension funds' average target allocation to US REITs is 10.1%, the actual allocation to REITs stood at 8.9% at the end of 2021. Unsurprisingly, then, 61% of institutional investors expect their allocation to increase in 2022-2023.

That means huge sums of institutional investment money (likely billions) is going to flow into REITs in the next few years. This will act as a massive tailwind for the REITs and industry sectors that capture the most of those institutional dollars.

Of course, one should not invest in a REIT based merely on pension funds' interest in that REIT. But observing what institutional investors are doing is useful to generate ideas as well as discerning emerging trends.

With that said, let's look at where pension funds are investing in the world of REITs.

Institutional Investor Activity In REITdom

S&P Global Market Intelligence recently released a report on the changes in allocation to REITs made by the investment managers of pension funds from the end of 2019 to April 25th, 2022. The results paint a picture of a stark divide between a pre-pandemic world and a post-pandemic one.

Below, we've highlighted in green the five REIT sectors in which pension funds significantly increased their ownership share from the end of 2019 to April 25th, 2022. Likewise, we highlighted in red the two sectors that have seen the most significant decline in pension plan ownership.

As you can see, the five REIT sectors in which pensions have significantly increased ownership are:

1. Multifamily (up 47%);
2. Industrial (up 103%);
3. Self-storage (up 90%);
4. Data center (up 50%);
5. Single-family rental (up 172%).

Meanwhile, the two most significant sectors in which pensions decreased ownership are:

1. Shopping center (down 16%)
2. Regional mall (down 53%)

You might think that these investment decisions were made during the uncertainty of the pandemic and tell us little about pensions' future plans. But based on the most recent data available (the PREA survey mentioned in the introduction), the above changes basically reflect pensions' investing priorities right now.

Of all investment dollars earmarked for real estate, the PREA survey found that pension fund investment managers are planning to deploy 31% to multifamily this year, while 28% of planned capital deployments should go to industrial.

What about office? This property type is probably the most hotly debated in the commercial real estate space in the wake of COVID-19. While there are certainly defenders of office real estate as maintaining its utility and desirability for tenants even in a hybrid work environment, there are also plenty of detractors who believe office occupancy and usage will never return to pre-pandemic levels.

As for pension funds, they increased their allocation to office REITs during this uncertainty for a few reasons.

• First off, office has historically been the core component of commercial real estate, and pension funds are notoriously slow to change or adapt to new environments;
• Second, while private real estate values held steady for office buildings during the pandemic, office REITs took a huge hit. This created an arbitrage opportunity of which institutional investors took advantage.

That said, the PREA survey shows that office is going to attract much less institutional capital going forward.

Turning to individual stocks that pensions have increased and decreased stake in over the last two years and four months, we find some interesting and unexpected reshuffling.

First off, the single REIT in which pensions increased their stakes the most over the last few years is Hudson Pacific Properties (HPP), an owner of office properties primarily on the West Coast. This was likely an arbitrage play as previously discussed, as HPP shed around 45% of its value in the early stage of the pandemic.

The second most added REIT was industrial cold storage owner/operator Americold Realty Trust (COLD). Pensions that bought this company in 2020 and the first half of 2021 are likely sitting on a loss, as labor shortages and supply chain problems have hurt COLD's performance and caused the stock to plunge 30% from Summer 2021.

The multifamily landlord UDR Inc. (UDR) was an interesting top pick for pensions in the apartment space, at least until you discover that over long time periods, UDR has outperformed all of its coastal multifamily REIT peers on a total return basis.

Another notable addition from pensions is Alexandria Real Estate Equities (ARE), classified as an "office" REIT but really a Class A life science laboratory real estate owner and developer. COVID-19 proved to both society and pharmaceutical companies that drug research and development is essential to human progress, and it can't be performed at home.

Unsurprisingly, most of the names on the list of top dispositions among pensions were in regional malls, shopping centers, and hotels.

It is not too surprising to see highly leveraged Class A mall owner Macerich (MAC) at the top of the disposition list, as the REIT was ill-prepared for a pandemic and had to cut its dividend down by 80%. While pensions owned over 20% of MAC just prior to COVID-19, they now own only 2.2% of the company.

More surprising is the mass dumping of Federal Realty Investment Trust (FRT), the blue-chip Dividend King with the longest dividend growth streak in REITdom at over 50 years. Pensions now own a mere 0.3% of FRT. It appears institutional investors believe FRT's best days are behind it.

Much the same could be said for Simon Property Group (SPG), the blue-chip REIT in the high-end mall space, although SPG did need to cut its dividend during the pandemic.

When looking at the top REITs by pension fund ownership, we find a number of legacy office landlords still holding large shares of pensioners' invested dollars. Outside of the traditional office, ARE holds the largest share of institutional investment, followed by coastal, urban multifamily REIT Equity Residential (EQR).

Despite pension funds voracious appetite for industrial REITs at the present moment, the only industrial REIT to make the top 15 is COLD. Meanwhile, the only shopping center REIT to make the list is Regency Centers (REG), widely considered the highest quality and best operated in this space with mostly grocery-anchored centers.

Why JBG SMITH Properties (JBGS), the perennially poor-performing mixed-use center developer in the Washington D.C. area, is the fifth most owned REIT among pension funds is a mystery. Perhaps they were lured by the prospect of owning the REIT that is developing Amazon's (AMZN) new headquarters in Northern Virginia.

Bottom Line

One of the primary takeaways from the five REIT sectors in which pension funds are increasing ownership is that institutional investors expect inflation to persist for a while, at least in certain pockets like housing.

At High Yield Landlord, we agree that residential REITs should continue to perform well for the foreseeable future, but our top picks in this space would be two REITs that the pension funds seem to have overlooked:

1. BSR REIT (BSRTF): BSR is a multifamily REIT that transitioned heavily into the three major Texas markets of Dallas, Houston, and Austin at nearly the perfect time. The REIT's net asset value per share soared 66% from Q1 2021 to Q1 2022. Today, BSR trades at an astonishing ~22% discount to NAV and offers a well-covered 3% dividend yield.
2. UMH Inc. (UMH): UMH is an owner/operator of manufactured home communities primarily in the Mid-Atlantic region, with a home rental portfolio of 8,800 units. After a strong run over the last few years, UMH has pulled back by 25% year-to-date and now offers a growing, 4%-yielding dividend.

By being selective and contrarian, we believe it is possible to beat the staider and more conventional pension funds.

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