any institutional investors,high-net-worth individuals and investment advisers have lately sought bigger returns by increasing their allocations to real estate: usually by investing directly in bricks and mortar,or in private equity real estate investment funds.
However, research recently published by the Washington-based National Institute of Real Estate Investment Trusts
(NAREIT) and by Cohen & Steers Capital Management of New York shows that real estate investment trusts (REITs) have steadily outperformed private equity real estate funds, in good times and bad, over more than 30 years for which index data
are available.
Several factors contribute to REITs’ strong performance. The most immediately obvious one is the difference in the fees charged by REITs and private funds. Another, almost as evident, is the quick liquidity of REITs. A third is the lower leverage that REITs typically employ — they’re far less debt-driven than are most private equity real estate funds.
Last but far from least is the typical REIT’s business model. It buys low and sells high: an elementary axiom, it would seem to most observers, but one seldom followed by other real estate investors.
“The REIT industry overall has turned in very strong long-term returns, averaging more than 10% per year over the past 10, 20, and 30 years, so there isn’t much that needs to be done to make them more attractive,” says Craig Leupold, president of Green Street Advisors in Newport Beach, Calif. “REITs provide proper alignment of interests, have good corporate governance, enjoy access to capital, employ more reasonable leverage when compared to most direct real estate investments, are more liquid than private-market real estate and have generated solid long-term total returns. Many investors are attracted to the current dividend yield and the safety that real estate provides, given the uncertain outlook for long-term inflation.”
Investors are attracted by the high-quality real estate that most REITs own, Mr. Leupold adds, as well as their strong management teams and solid balance sheets.
“We expect to see continued growth in the REIT industry over the next several years,” he says, “as the strong returns they have generated and their structural merits become better understood by the investment community. We expect REITs will continue to de-leverage by funding a greater portion of their acquisitions with equity.”
A paper recently published by Cohen & Steers asserts that listed REITs have outperformed core and value-added real estate funds consistently over the long term, while providing the benefit of liquidity.
“Over the past 30 years,” the report says, “which encompass two commercial real estate crashes [19891992 and 2008-2010], REITs have outperformed diversified core funds by 470 basis points annually. Over the past 10 years, REITs have outperformed core funds by 560 basis points annually.”
Over a 15-year period, according to Cohen & Steers, actively managed REIT investors realized an annualized 10.6% return. Of the other active strategies, opportunistic real estate funds placed second, at 9.8%. Core and value-added funds had average annualized returns of 6.5% and 5.6%, respectively, over 15 years.
“If you own buildings directly, the cost of changing your mind is pretty high,” adds Joseph Harvey, president and chief investment officer at Cohen & Steers.
“It takes time to market the building; there are other associated costs, and times where you just can’t sell the property. REITs have done so well, in part, because typically the people running these companies are shareowners, and they have incentive compensation programs based on performance. Over time, the public market acts as a governor of what public companies do. If REITs invest over-actively and pay too high a price, they’ll pay for it on the market and their stock prices will go down. Thus, REITs are pushed into making better decisions and if you’re a shareholder in a REIT, but change your mind, you can sell your shares very easily,” he says.
NAREIT recently reported that REIT returns were nearly five times greater than those of the broader U.S. equity market in the first three quarters of 2010. The FTSE NAREIT Equity REIT Index delivered a 19.1% total return and the FTSE NAREIT All REITs Index delivered an 18.5% total return for the period. This compared with 3.89% for the S&P 500.
For the 12-month period ended Sept. 30, REITs nearly tripled the returns of the broader market, with the FTSE NAREIT Equity REIT Index delivering a 30.28% total return and the FTSE NAREIT All REITs Index delivering 28.27%, compared with 10.16% for the S&P 500.
Private investors who wish to buy REIT stock have many options. An investor might do the research himself, and choose individual REITs; he might invest in a fund of REITs that owns a diverse portfolio; he could ask an adviser to put together a customized portfolio, or could simply tell a broker, for example, “Buy me the five best apartment REIT stocks.”
Another option is to invest in non-exchangetraded REITs. These are public companies, and thus subject to oversight by the Securities and Exchange Commission, but because they’re not traded on a stock exchange they’re more like a direct investment in real estate.
“We expect to see continued growth in the REIT industry over the next several years,as the strong returns theyhave generated and theirstructural merits become better understood by theinvestment community.”
“These vehicles are not as liquid as a traded REIT,” says Marc Nemer, president of Cole Real Estate Investments in Phoenix. “They are long-term holds. Their investors usually want a diversified stream of income that’s independent of the stock and bond market. Our investments focus on the highest-quality commercial real estate, generally net-leased to industry-leading corporations on a long-term basis and acquired at 40% to 50% loan-to-value.”
REITs are available to cover a broad range of property types — from shopping malls to timberlands — and in a wide range
of structures.
“We’re not bashful about telling the REIT story,” says Bryce Blair, CEO of AvalonBay Communities, an apartment REIT based in Arlington, Va., and incoming chairman of NAREIT. “REITs are forward-looking investment vehicles. Public company valuations hit their trough in the first part of 2009, and have rallied since then, with the FTSE NAREIT U.S. Equity Index up over 175% from its trough. On the other hand, private markets valuations have been much slower to recover.
“One of NAREIT’s principal jobs is to get the REIT story out, to provide support to investors and to show the public the benefits of investing in REITs. NAREIT is also working with Congress on several important legislative initiatives such as modifications to FIRPTA [the Foreign Investment in Real PropertyTax Act] that would encourage more international equity investment in U.S. REITs,” Mr. Blair adds.
By Joseph Dobrian
