Real estate investment trusts (Reits) will increasingly represent a strong investment over the next few years as growth returns to the global economy, though individual stock selection is crucial to finding profitable exposure.
Property trusts offer investors an opportunity to buy into commercial construction projects while keeping their investments liquid. Returns are generated through rental prices, which is where the risk in Reit speculation lies. As real estate is a sector particularly vulnerable to market fluctuations, the value of the assets held in Reits can change quite rapidly with the value of the real estate. Ten-year average US Reit returns in December 2010 were 10.76% as opposed to 1.41% for the S&P 500 index and 3.94% for the MSCI EAFE. As a result of low correlation to other asset classes, Reits are also a potential source of portfolio diversification.
The Neuberger Berman Reit team is currently optimistic about the outlook for US Reits, hedging bets on this prediction by maintaining exposure to the more defensive healthcare property sector. The team is confident that fundamentals bottomed in the third and fourth quarters of 2010, making 2011 an important year for investors looking to move into or increase their exposure to the sector.
The major market correction from January 2007 brought down the value of Reit funds until Q1 of 2009, when fiscal recovery began to push up capital. Because in 2010 the equity Reit market rebounded from recent lows to a market capitalisation of $350 billion – the highest valuation since 2006 – 2011 is poised to continue to deliver high returns.
Neuberger Berman reports that dividends are beginning to increase, with real estate companies already starting to profit from fiscal recovery. This year, the company anticipates earnings growth of between 7% and 9%, up from 3.5%, with dividends delivering an average yield of 4%. ‘Reit dividends are now stabilised and we believe they are poised to grow over the next few years as Reits experience increases in cash flow and taxable income,’ a company report stated.
Having outperformed the FTSE NAREIT All Equity REIT Index every year since inception, the Neuberger Berman US Real Estate Securities fund is notable for its management of a relatively modest $800 million. The company’s size allows it to eliminate the smallest cap Reits, which knocks the index of 126 trusts down to 90. From that reduced range of investments, the team selectively bet on between 35 and 45 funds. ‘Once you own about 50 of them you essentially own the index,’ said managing director Elizabeth Reagan.
The greater liquidity of Reits over bricks and mortar investments makes them a strong asset. As they control close to $600 billion, in debt and equity, of commercial real estate assets in the US they are also well placed to capitalise on global economic growth. Though demand for real estate is tied to, but lags slightly behind, progress in the broader economy, supply is at a historic low and the industry is therefore naturally well positioned for investment. Lack of funding will ensure that supply remains depressed in commercial real estate, which is likely to benefit Reit investors.
‘Reits have proven to have better access to capital than other owners of real estate and are beginning to benefit from acquisition opportunities related to the recapitalisation of overleveraged owners,’ Neuberger Berman reported. Between 2005 and 2007, private speculation on commercial property was funded with readily available financing with an average five to seven-year payment scheme. As these loans begin to mature, US Reits will be well positioned to acquire properties from distressed sellers. ‘We expect to see some of the highly levered, privately held commercial real estate owners opt to IPO [initial public offering] their portfolios as a way to refinance their properties,’ Reagan said.
The firm has particularly bullish positions in Boston Properties (BXP), a Reit that has commercial property positions in Boston, Washington DC, Midtown Manhattan and San Francisco. A substantial 4.96% of Neuberger Berman’s portfolio is invested with the company. ‘We like Midtown Manhattan office space, and to some extent Downtown, since they are prime areas for corporate headquarters.
Industrial warehouse Reits with exposure to major transport hubs are also attractive investments, as they benefit from global trade,’ said Steve Shigekawa, managing director at the firm. ‘Chicago, in particular, is a transport hub and so is well positioned to sustain a strong property market.’