REITs dig back into good graces of investors

Institutional investors are rediscovering real estate investment trusts as returns and supply-demand dynamics heighten their allure for the first time since the financial crisis.

This year alone, domestic and international asset owners including the $233.9 billion California State Teachers' Retirement System; the €70 billion ($1.13 billion) Bayerische Versorgungskammer, Germany's largest public-sector pension group; and the $897 million Chicago Firemen's Annuity & Benefit Fund added REIT mandates or allocations.

Institutional investors in the U.S. have awarded six REIT mandates so far this year, up from four mandates in all of 2018, said Meredith Despins, Washington-based senior vice president, investment affairs and investor education at Nareit, citing data from Fundmap and Nareit.

As REIT returns have started to recover, investors also are attracted to REITs as a more liquid form of real estate that can help them create more directed real estate portfolios, access newer property types such as cell towers and manage their real estate portfolios.

In May, West Sacramento-based CalSTRS made its first REIT investment, committing $100 million to Principal Real Estate Investors for a U.S. mandate. Over the long term, officials expect the fund's REIT portfolio will make up 5% to 10% of the pension fund's $29.9 billion real estate portfolio, said Mike DiRe, CalSTRS' director of real estate.

CalSTRS has had the ability to invest in REITs for some time, he noted.

"We had it in our policy that we could invest in REITs but we never acted on it," Mr. DiRe said. "More and more investors are adding REITs and making it part of their real estate portfolio. It's part of our toolkit, especially in areas we can't access otherwise."

REITs have a better liquidity profile and allow investors to have a more directed portfolio, he said. For example, real estate open-end funds are similar to REITs but the open-end fund pools tend to hold a wider array of sectors than REITs, which tend to be focused on a specific property type and/or region. Additionally, investors can't get in and out of an open-end fund as easily — there are often queues of other investors waiting to invest or redeem their stakes, Mr. DiRe noted.

"We can use REITs to add specialty asset types such as cell towers, medical offices, student housing and senior housing. A lot of these categories the REIT markets covers very well," Mr. DiRe said.

CalSTRS can also use REITs to manage its real estate portfolio, he said.

"Pension fund investing is a long-term game. We think our REIT exposure could lean in and lean out," he said. "When and if REITs get overpriced, I would hope we would underweight them."

Global investors are also moving more capital into REITs. In May, Bayerische Versorgungskammer, Munich, hired Cohen & Steers Inc. to manage U.S. and European real estate securities via two real estate investment trust mandates. It also hired Timbercreek Investment Management Inc. for a mandate to manage a portfolio of European-listed REITs and B&I Capital AG for a global REIT mandate. BVK's overall allocation to REITs was €1.3 billion as of Dec. 31.

For now, REIT returns are starting to come back to life after being in the dumps since the financial crisis, said Rick Romano, a managing director and head of the global real estate securities business at PGIM Real Estate.

Until last year, REITs underperformed the broader equity markets, said Mr. Romano, who is based in Madison, N.J.

"Since the election in 2016, we had a period where investors were chasing growth at all costs," Mr. Romano said.

REIT returns this year have surpassed the broader stock market returns. The FTSE Nareit All REITs Index (the broadest U.S. REIT index, which contains mortgage REITs as well as equity REITs) was up 22.38% so far this year to June 19. The FTSE Nareit All Equity REITs Index was up 23.23% for the same period. By comparison, the S&P 500 was up 17.88%.

Last year, the FTSE Nareit All REIT Index was -4.10% and the FTSE Nareit All Equity REIT Index was -4.04%, while the S&P 500 was down -4.38%.

In 2018, economic conditions became more attractive for REIT investment with benign interest rates and supply growth generally below global averages in most sectors and geographies. What's more, rising stock prices have resulted in investors' portfolios becoming overweight in equities, leading some to rebalance into REITs, he said.

PGIM executives expect that within property types where there are REITs trading below net asset values and good economies of scale, there could be more mergers and acquisitions as well as REITs taken private this year, Mr. Romano said.

"We see M&A and privatizations as a positive," he said. Net asset values of many of the REITs that are acquired, merged or taken private will go up as a result.

An exception is a merger of equals, which does not generally result in a rise in the REIT net asset value, he noted.

As of March 31, PGIM's REIT business had $2.9 billion in AUM.

Last year was the biggest for REIT mergers and acquisitions by total deal volume in 11 years, according to Nareit data. So far, this year there have been four mergers and acquisitions, Nareit data show.

REITs investing in New York offices and West Coast offices, for instance, are trading at large discounts to their net asset values, he noted. Public markets take a short-term view and look at the supply of offices that needs to be leased up, Mr. Romano said.

For investors, REITs are an opportunity to "buy real estate cheaper on Wall Street than on Main Street" and with greater liquidity, Mr. Romano said.

While most of the substantial amounts of capital flowing into real estate is invested in private real estate, there has been a meaningful uptick in the number of REIT mandates this year, said Nareit's Ms. Despins.

Indeed, the decision by CalSTRS' officials to make its first-ever REIT investment will carry some weight, she said.

"This is a ... significant event from a REIT perspective and a portfolio investment perspective," Ms. Despins said. "It sends a very strong message to the markets that REITs are real estate."

Pension funds have invested in real estate for many years, but the real estate equity and the REIT industries have changed. Investors are now considering REITs part of their real estate rather than their equity portfolios.

"This really is an evolved way of approaching a real estate allocation, using REITs in addition to other real estate investments like investing directly in properties and in real estate funds. It allows investors to position their real estate portfolios for the 21st century," Ms. Despins said.

In addition to the major property types of multifamily, retail, office and industrial, investors can get exposure to newer property sectors such as infrastructure and data centers, she said.

"They are sectors investors can't access as efficiently in the private real estate market as in the public real estate market," Ms. Despins said.

Executives in BlackRock Inc.'s real assets business have noticed increased investment in REITs.

"We are seeing huge flows into REITs in the last year," said Anne Valentine Andrews, New York-based managing director, global head of funds management and chief operating officer for BlackRock's real assets group.

In the past two years, BlackRock's AUM in actively managed real estate securities has grown to $4.2 billion from $1.5 billion, with more than $1.7 billion in inflows year-to-date.