Insights

Portfolio Manager Eric Rothman of the Cromwell CenterSquare Real Estate Fund covers the performance of real estate investment trusts (REITs) in the first half of 2024, artificial intelligence’s impact on data centers, mergers and acquisition activity, and qualities REITs offer in a recessionary environment.

Would you please discuss REIT performance over the first half of 2024?

Despite the strong fundamentals of REITs, negative investor sentiment toward real estate hurt sector performance. Over the first half of the year, the real estate sector significantly underperformed the S&P 500 Index as investors appeared to be waiting for the Federal Reserve to reduce interest rates.

At the beginning of July, there was a swift shift in sentiment toward real estate following the encouraging inflation data that lifted the odds of a rate cut in September. REITs rebounded over 7% in July while the S&P 500 only rose 1%. Even with this strong monthly return, we believe REITs will continue tobe attractive to investors as they are historically undervalued relative to the overall market.

What impact is artificial intelligence (AI) leasing having on data centers?

The amount of AI leasing has exponentially increased over the past year. However in data centers, occupancies are full and there is a large backlog for new developments to meet AI demands, resulting in many large technology companies paying a premium for space. Even as more data centers are being built, there is a constraint on power availability and the transmission as AI chips consume approximately 5-6 times more electricity than traditional server chips.

As it pertains to the Fund, with data centers comprising 11% of the portfolio as of the end of the second quarter, we believe the Fund is poised to benefit from this trend.

What merger and acquisition (M&A) activity did you see in the real estate market?

M&A has been largely muted and primarily driven by large private equity firms in 2024. For example, Blackstone, an investment management company, acquired Apartment Income REIT Corp. for $10 billion and Tricon Residential for $3.5 billion this year.

Other than some episodic activity, many REITs appear to be waiting for the Federal Reserve’s rate cut actions. Therefore, clarity over the direction of rates could be a catalyst for increased M&A activity in the sector.

What qualities do REITs offer investors in a recessionary environment?

REITs are hard assets that tend to be less economically sensitive compared to other areas of the market due to their:

• Durable cash flow. Real estate operating cash flow has proven to be defensive in past recessions. At the property level, REITs, as represented by the FTSE NAREIT All Equity REIT Index, have averaged about 3% net operating income growth annually over the past 25 years.
• Well-covered, growing dividend. REITs across the entire universe have averaged a 73% payout after deducting the amount of capital needed to maintain and manage the assets. In addition, dividend growth continued: Over the first half of 2024, about 35 REITs have increased their dividend and this dividend growth averaged approximately 8%.
• Lower market correlation. As of 12/31/23 based on monthly performance, the 10-year average correlation between the S&P 500 and the FTSE Nareit All Equity REITs Index was 0.76.¹

For the Cromwell CenterSquare Real Estate Fund, we focus on primarily high-quality REITs in what we consider to be the best urban and suburban markets in the U.S. Diversified across the real estate spectrum, the Fund seeks Class A properties including towers, warehousing logistics facilities, single-family residential, office, retail, and hotel subsectors that have compelling valuations. We believe this focus on high-quality assets has resulted in Morningstar awarding the Fund with an overall “Below Average” Risk Rating among its Real Estate Fund peers as of July 31, 2024.