Ali Zaidi
Indrani De, CFA
- REIT index performance can be a leading indicator for the asset class as a whole.
- Our latest Asset Allocation report records a strong quarter for listed real estate, showing signs of a long-awaited resurgence.
- A deeper analysis of sectoral returns since the Great Financial Crisis reveals no clear pattern, vindicating a broad sectoral exposure
Global commercial real estate valuations have been falling since the beginning of the year as rising rates have driven rapid cap-rate expansion. Operating fundamentals remain stable for most property sectors, and the unprecedented pace of rate hikes has had an unsettling effect on the macro level for commercial property.
REITs can serve as a leading indicator to the wider asset class by virtue of being listed and therefore more tradeable than bricks and mortar, so they are currently of particular focus for any signal of a reversal. Our latest Asset Allocation’s quarterly Insights report recorded signs of turnaround and a relatively strong quarter one for the listed RE sector, with improving sector breadth and some of the worst hit geographic markets in the last 12 months showing good performance in the last three months. However, concerns about refinancing maturing debt with current higher rates remains a focus.
Fundamental drivers of property return vary in potency, depending on where we are in the business cycle. In addition, individual property sectors have specific set of drivers that manifest over long term. The intertwined nature of business cycle and asset-specific drivers suggest that investment decisions should include a focus both on holding period and the underlying sector exposure.
As economic intuition would entail, REITs have exhibited correlation to the performance of underlying property assets. They also have a significant beta in the short run to equity markets due to being listed, and the rates environment, which is a major macro driver. FTSE Russell’s property sector indices dissect the global benchmark effectively to compare sector level return variation, and comprise of 11 distinct property types, with the recent additiobn of Data Center and Specialty. This commentary aims to highlight the return variations between different property assets and implications of a narrow allocation. Put another way, we use data extending back to 2006, the last time rates were at current levels, to highlight the importance of property sector allocation for real estate investors.
Sector composition is a leading factor for performance attribution for real estate, so a sector-level lens is a useful tool for both strategic, in the context portfolio completion or tactical for a rapid allocation on specific convictions. The expanded opportunity set of the current benchmark[2] combined with meaningful gap between the top and bottom performing property type, 24% on average, offers ample room for active management.
Real Estate Sector Ranking by Year - Performance for sector driven by market cycles and secular demand
Source: FTSE EPRA Nareit Global Sector Index performance TR USD.*08-2023
Annual TR by year – Property Sectors
Ranking the sector returns since 2006, the spread in any given year indicates distinct drivers for each property type. Furthermore, no single property sector is consistently above or below the benchmark throughout, as relative to the benchmark reflects both the business cycle and structural trends. For instance, the well-known retail assets’ re-pricing due to headwinds from e-commerce growth from 2016 until the pandemic (a structural trend), was preceded by a period of outperformance. While Lodgings & Resorts, reflecting level of business and leisure travel and therefor higher cyclicality, deviate the most from the benchmark in both directions. At the same time, Self-Storage and Industrial assets have benefited from multi-year momentum.
| Self Storage | 12.11% |
|---|---|
| Residential | 7.46% |
| Specialty | 7.31% |
| Health Care | 6.72% |
| Data Centers | 5.35% |
| Industrial | 4.57% |
| Industrial/Office | 4.15% |
| Global | 4.10% |
| Office | 2.53% |
| Retail | 2.40% |
| Diversified | 1.95% |
| Lodging/Resorts | 0.73% |
Annualised TR 2006-2022 – Property Sectors
Furthermore, annualized returns 2006-2022, indicate that the simple approach of Core3 vs. Alternative sectors may be sub-optimal in given years. Indeed, until the run up to the pandemic, Residential, one of the core sectors, had above benchmark returns for eight years. A period of historic low borrowing rates that boosted residential asset valuations. REITs served as an effective proxy for residential property returns on the global scale, during this time. Annualized returns from Residential since 2006 rank second overall. Furthermore, Industrial asset performance has been above benchmark for an extended period, also a core property sector.
| 2006 Annual TR by year -Regions | 2007 | 2008 | 2009 | 2010 | 2011 | 2012 | 2013 | 2014 | 2015 | 2016 | 2017 | 2018 | 2019 | 2020 | 2021 | 2022 | 2023* |
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Highest Index Return | |||||||||||||||||
| APAC 43.43% |
APAC 45.52% |
Europe 6.67% |
America 8.18% |
Europe 29.12% |
APAC -1.46% |
Europe 27.34% |
|||||||||||
| Europe 66.99% |
APAC 14.80% |
America -40.63% |
Europe 40.45% |
America 28.65% |
America 8.19% |
Europe 30.70% |
Europe 16.21% |
America 28.15% |
America 1.81% |
APAC 6.11% |
APAC 16.10% |
America -3.89% |
America 24.51% |
Europe -1.87% |
America 42.60% |
APAC -10.96% |
America 4.68% |
| EPRA Nareit Developed 42.35% |
EPRA Nareit Developed -6.96% |
EPRA Nareit Developed -47.72% |
EPRA Nareit Developed 38.26% |
EPRA Nareit Developed 20.40% |
EPRA Nareit Developed -5.82% |
EPRA Nareit Developed 28.65% |
EPRA Nareit Developed 4.39% |
EPRA Nareit Developed 15.89% |
EPRA Nareit Developed 0.05% |
EPRA Nareit Developed 4.99% |
EPRA Nareit Developed 11.42% |
EPRA Nareit Developed -4.74% |
EPRA Nareit Developed 23.06% |
EPRA Nareit Developed -8.18% |
EPRA Nareit Developed 27.21% |
EPRA Nareit Developed -24.41% |
EPRA Nareit Developed 1.98% |
| APAC 36.49% |
America -14.92% |
Europe -51.13% |
America 32.22% |
APAC 17.21% |
Europe -12.34% |
America 18.14% |
APAC 4.37% |
Europe 10.41% |
APAC -7.25% |
Europe -7.28% |
America 4.57% |
Europe -12.13% |
APAC 17.10% |
APAC -9.08% |
Europe 9.96% |
America -24.84% |
Europe 1.84% |
| America 36.26% |
Europe -24.50% |
APAC -52.48% |
Europe 9.23% |
APAC -19.61% |
America 1.27% |
APAC 0.22% |
America -9.75% |
APAC 4.34% |
Europe -40.45% |
APAC -5.07% |
|||||||
| Lowest Index Return | |||||||||||||||||
| Americas 5.61% |
| Global 4.1% |
| APAC 2.67% |
| Europe 1.42% |
Annualised TR 2006-2022 - Regions
Geographic annualised performance for the period places the Americas above the benchmark by 150 bps. The outperformance of Americas is a function of both the underlying sector exposure, and also the listed equity beta to the US equity markets which have been the clear out-performer since the Great Financial Crisis. The US REIT market constitutes a higher share of REITs over non-REITs and a larger weight of the strong performing alternative sectors. Having said this, growth rate of Asia and age-dynamics in Europe remain key drivers, at the very least on sector exposures of Industrial and Healthcare, respectively.
REITs by weight i Regional Indexes
Source: FTSE Russell. Past performance is no guarantee to future results. Please see the end for important disclosures.
Alternative property sector weights
Source: FTSE Russell. Past performance is no guarantee to future results. Please see the end for important disclosures.
In the current phase of the property cycle, cap-rates are to remain sensitive to interest rates and near-term economic outlook (e.g. the correlation of EPRA NAREIT Global index to real global yields increased from 76% in last 3 years to a high 85% in last 1 year ending 08/2023, per the latest quarterly Asset Allocation Insights report). At sector level the repricing is expected to play out at varying degree also due to supply levels. For instance, high level of residential property completions in US would suggest decompression of cap-rates, however, this coincides with lowest affordability in over two decades. Supply or rate of completions for other sectors e.g. Life-science offices and cold-storage Industrial is in sharp contrast, highlighting the case for a sector distinction.
Given, sector specific drivers can be identified and even narrowed on a regional level, allocations can be aligned to risk profiles of various mandates, in conjunction with convictions on business cycle and structural factors. As listed real estate offers access to property cash-flows with the liquidity associated of public equity market access, these allocations can be effcetively global with cost-advantage and unmatched liquidity.
[2] FTSE EPRA Nareit Developed Index
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