Commentary - December 2023CenterSquare Real Estate Fund
Portfolio Manager Eric Rothman discusses the 2023 real estate investment trust (REIT) market, subsectors that look attractive, the role REITs play in a portfolio, and the outlook for real estate assets in 2024.
Would you please summarize the effect that interest rate hikes have had on REIT investments?
Over the past 18-24 months, the Federal Reserve’s monetary policy has weighed on the sentiment for REITs, resulting in deep discounts to valuations. In fact, as of September 30, 2023, the FTSE Nareit All Equity REITs Index traded at a 20% discount to its forward net asset value. In the “modern REIT era” that incorporates the past 30 years, a 15% discount has been breached only nine times. These periods tend to be brief, occur in periods of market crises, and signal to investors that REITs are oversold.
Indeed, when the Fed announced that it was near the end of its hiking cycle at the beginning of November, the view towards REITs improved and the Index rebounded 12% in the month—its best return since 2011. Strong returns also continued in December, significantly narrowing the discount that REITs were trading at.
How has the composition of REITs changed in the “modern REIT era”?
The REIT market has become more than the traditional “four food groups” of retail, industrial, office and apartments. The new economy of real estate that represents a meaningful majority of the overall market includes data centers, cell phone towers, cold storage units, life science buildings, biotechnology, self-storage units and single-family residential. One notable fact: The combined weighting of traditional office, regional malls and hotels in the FTSE Nareit All Equity REITs Index comprise only about 10.5%. Data centers make up more of the Index than those three subsectors combined.
Alternatively, the areas we have been avoiding include regional malls given changing demographics and potentially limited consumer spending in the inflationary and higher rate environment.
What role do REITs play in an overall asset allocation?
As a total return vehicle with historically less correlation to the equity market, publicly traded REITs offer diversification in an overall portfolio. REITs have both equity and fixed income investment elements, offering the potential for capital appreciation along with an income component. REITs also have a different return profile and durable cash flow, which should provide a less volatile income stream. We also have seen many REIT dividends continue to grow. In 2023, there were almost 90 dividend increase announcements, with an average increase of approximately 9%.
What is your 2024 outlook for publicly traded real estate assets?
The Fed’s end to rate hikes should have positive implications on publicly traded REITs. Historically, after the Fed has stopped raising rates, REITs have rallied. In the ensuing 90, 180 and 365 days, publicly traded REITs rose, on average, 9.3%, 13.9% and 20.1%, respectively. They have also outperformed private real estate and the broader equity market.
Even with the year-end rally in REITs, they are trading at a discount relative to history. As of the end of 2023, the FTSE Nareit All Equity REITs Index had a 15x forward earnings multiple; historically it has ranged in the mid-twenties.
Past performance is not a guarantee of future results. Index returns are not indicative of fund performance. Click here to obtain Fund performance.
The NFI-ODCE (NCREIF Fund Index – Open-End Diversified Core Equity) is a fund-level capitalization weighted, time-weighted return index and includes property investments at ownership share, cash balances and leverage (i.e., returns reflect the fund’s actual asset ownership positions and financing strategy).
Correlation measures the extent to which two variables are related.