Insights

Portfolio Manager Eric Rothman highlights how real estate investment trusts (REITs) have historically performed after the Federal Reserve ends its hiking cycle, what changes were made to the portfolio and REITs’ attractive attributes.

Why do REITs present an especially attractive opportunity today?

We would highlight two points about publicly traded REITs that investors may want to pay close attention to:

1. REITs are trading at a rare 15% discount. Usually investors pay roughly net asset value for publicly traded REITs. Yet, as of June 2023, REITs, as measured by the FTSE Nareit All Equity REIT Index, traded at a 15% discount to NAV, which is a rare occurrence. In fact, over the past 25 years, REITs have only traded at a 15% or greater discount 8 times and on average for only a brief period each of these times. Subsequent to reaching this level, REITs delivered strong results with average cumulative returns of 28.6% in the ensuing one year and 59.6% after three years.
2. The end of Fed tightening may be a bullish signal. Following the end of a Federal Reserve interest rate tightening cycle, REITs have historically experienced strong returns, and even outperformed the overall market. Over the past approximately 30 years, there have been four such periods. In the 90-day, 180-day and 1-year periods after the Fed ceases to raise rates, REITs have risen an average of 9.3%, 13.9% and 20.1%. 

Given the macroenvironment and interest rate level, what changes were made to the Fund’s portfolio and why?

We are focused on defending the Cromwell CenterSquare Real Estate Fund against a potential recession.

While there could be an additional interest rate hike by the Federal Reserve, rates are unlikely increase another 500 basis points. With higher rates, we have reduced the Fund’s exposure to net lease, which tend to own assets with long leases but little growth. Because these companies have seen their cost of capital rise, they may not be able to achieve the investment spreads that they have in the past.

The Fund’s exposure to Industrial REITs was reduced as it is an area that had become relatively expensive. While many REITs in this sub-sector enjoy very strong fundamentals, these fundamentals are beginning to show signs of deceleration. In addition, excess supply has started to creep into the market.

Lastly, we reduced exposure to apartments especially in the sunbelt as higher new supply is having a short-term impact and as rental rate growth has flattened and even declined and we anticipate job growth to diminish.

Alternatively, the subsectors that look more promising include the single family residential REITs; health care, in particular senior housing; and data centers, which have had leasing momentum because of the increased interest in artificial intelligence (AI).

Looking ahead to the rest of 2023, what attributes do REITs possess that strengthen an investor’s portfolio?

We believe REITs play an important role in an investor’s portfolio with more defensive characteristics:

• Durable cash flow. Real estate operating cash flow has proven to be defensive in past recessions. At the property level, REITs have averaged about 3% net operating income growth over the past 25 years.
• Well-covered, growing dividend. REITs have averaged a 70% payout after deducting the amount of capital needed to maintain and manage the assets. In addition, the dividends are growing: So far in 2023, 51 REITs increased their dividend an average of nearly 11%.
• Lower market correlation provides diversification. As of 12/31/22 based on monthly performance, the 10-year average correlation between the S&P 500 and the FTSE Nareit All Equity REITs Index was 0.72.¹

In addition, unlike private real estate funds, the Fund invests in publicly traded securities, strikes a daily NAV, and offers daily purchase and redemption of shares without restrictions.