23rd Jun 2020 by Helge Kostka

Bricks & Mortar

bricks

News on suspensions of redemptions from major UK open ended property funds as well as underperformance year to date have further underpinned the fact that MASECO has been a long-standing proponent of measured allocations into REITs.


 

Indeed, while the US DJ Select REIT index has dropped 22.92% (Source: Morningstar) as at the end of April since the start of the year and thereby investors fared worse than those losing 9.46% in line with the S&P 500, long term investors have benefitted from allocations in REITs:

Source: Morningstar, April 30th 2020

Explaining REITs

Real estate assets are illiquid, but different fund formats allow investors to buy and sell fractional, indirect ownerships of real estate. REITs are real estate investment trusts. Most of them are equity REITs that have issued a certain number of shares that are tradable intraday on different stock exchanges. The daily value of a REIT’s assets is estimated.

To qualify as a REIT, a company must fulfil certain requirements with respect to owning income generating real estate and distribution of income to shareholders. According to REITs.com, US REITs that are listed on the stock exchange now own approximately $2 trillion in assets .

REITs can trade at a premium or a discount relative to their asset values. According to research published by PGIM, the European REITs market has sometimes been trading at a discount of 25-30% this year. .

Every REIT on its own is usually diversified across many different assets. For example, Prologis, the largest REIT holding in the FTSE EPRA NAREIT Developed Dividend + index, according to its website, owned 4660 buildings at the end of the first quarter of 2020.

The average REIT also takes on some debt; in other words, they apply some financial leverage. The below chart shows two ratios to measure leverage: Debt over book assets and debt over market assets. While the average US listed REIT was about 2 times leveraged for many years, when looking at former measure, the leverage increased substantially in the first quarter of 2020 when considering the later ratio due to changes in equity market value.

Source: S&P Global Market Intelligence, Nareit T-Tracket (R)

For all REITs the occupancy rate is essential with respect to receiving rental income. Thus far, these rates have not dropped due to the impact of the Coronavirus:

Source: S&P Global Market Intelligence, Nareit T-Tracker (R)

That said, funds from operations contracted by more than 10% per share over the last quarter, which was most likely caused by some occupants not paying their rent.

Sector Diversification benefits in REITs fund

Of course an investor can get seriously burnt with real estate investments as John Authers explained in his recent article: Real Estate's Demise Creates a Graveyard for Fools. This statement most likely holds true for the less skilled investor and the more concentrated exposure he or she has.

At MASECO we invest in broadly diversified REITs funds. The FTSE EPRA NAREIT Developed Dividend + index has over 300 constituents, spread all over the developed world. REITs are also from very different sectors. While many investors are aware of sectors such as office or residential REITs, the last decade has been dynamic, with the introduction of new sectors such as data centres.

Source: FactSet, Nareit. New Sectors includes cell tower, data center, self storage, timberlands, single family home, and farmland REITs. All Other includes all other sectors in the FTSE Nareit All Equity REITs index. Data as of December 31 2019.

The benefits of sector diversification are extremely evident, even if one looks only at US REITs. While REITs invested in shopping malls lost about 40% of their value in the first quarter and scarcely recovered in April, Industrial REITs have had positive performance year to date.

Source: Morningstar, as at 01 April 2020

Conclusions

Investors may benefit from REITs allocations because they diversify their equity exposure. REITs also feature a dividend income higher than that of broad equity markets. While REITs have not escaped from the economic impact of the current pandemic, and some may not survive due to asset concentration risks and high leverage, the exposures we prefer are broadly diversified from a security, country and sector level.

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Use of information: 

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Performance

  • Past performance is not a reliable indicator of future results. 

MASECO LLP (trading as MASECO Private Wealth and MASECO Institutional) is a limited liability partnership registered in England and Wales (Companies House No. OC337650) and has its registered office at Burleigh House, 357 Strand, London WC2R 0HS. 

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