Key Attributes Attract Attention
A number of factors are fueling pension plans’ interest in listed REITs for both existing and new investors. Performance is certainly at the top of the list for most investors.
REITs have outperformed private real estate by an average of 2% per year over the last 20-plus years, Worth notes. A second factor is access to 21st century real estate. “As the real estate landscape has changed, reflecting the shift to an increasingly digital economy, REITs have been on the front edge of that innovation,” he says.
“When we engage with clients directly, a lot of the conversation is around access to assets that are more difficult to get a hold of otherwise—non-traditional real estate sectors like self-storage, data centers, cell towers, and healthcare,” Rehan adds. Buying REITs is an easier way to deploy capital into assets that also have a very easy-to-manage wrapper and best-in-class management teams, he says.
Institutional clients who are new to the REIT space are taking notice of their strong performance relative to private real estate and other public securities, Smith says. Having said that, REITs from 2015 to 2020 underperformed broader equities and were out of favor. “I believe investors coming to the market in late 2020 and early 2021 were acknowledging that the REIT market has changed. They could get exposure to new growth sectors, and they were coming in at a time where they saw a buying opportunity,” he says.
Both existing REIT investors and those new to the space are gravitating towards growth sectors. The Nareit All Equity Index is a good indicator of the extent to which the market has evolved. “You can get a very quick allocation solution to some of the best-in-class operators in those emerging growth sectors in the public market, and we think that is going to continue,” Smith says.
Another reason for the growing appetite for REITs is the view that real estate has been a good hedge against inflation. “Since 1972, anytime inflation is above 2.5%, REITs have always outperformed the broad market. Maybe this time will be different, but history usually rhymes if not repeats,” Smith notes. On the operating side, it’s about pricing power, revenue growth, and dividend growth. The thesis being, if a company can grow its earnings and dividend in excess of the inflation rate, it should be a good inflation hedge.
REITS Complement Private CRE Investment
Increased capital flows to REITs also reflect more capital flowing to real estate and real assets allocations generally. According to the Pension Real Estate Association (PREA) 2022 Investment Intentions Survey, the average current allocation to real estate among global institutions is 8.9% with an average target allocation of 10.1%.
Pension plans are working to push more capital out to meet those targets, and there are different strategies at play within those real estate allocations. Some firms are deploying more capital to REITs, but maintaining the same percentage targets, whereas others are increasing targets for REITs, Rehan says. It also takes time to deploy capital into private real estate ventures. REITs provide a liquid alternative that allows pensions to put money to work immediately. So, REITs could be on the receiving end of an outsized share at the initial stage of an increased allocation to real estate, he says. “The question is how sticky that money will be when they do find other real estate opportunities,” he adds.
Pensions also take different approaches to how they use REITs within investment portfolios. REIT allocations can fall into either public equity or real assets allocations. “The increased funded status we have seen in recent years has given corporate DB plans incentives to increase allocations to income-generating assets as part of the growth portfolio as it ultimately reduces surplus volatility as the risk profile of REITs are more closely aligned to liabilities,” Rehan says.
Various corporate plans, for the first time in a long time, are sitting on surpluses and are willing to de-risk their equity allocation by putting money into REITs, Rehan says. In portfolios where REITs are part of the real assets allocation, plans that are more liquidity constrained, due to large upcoming payments or a high commitment to illiquid assets in their overall portfolio, pensions are viewing REITs as a liquidity solution, he says.
“Pension plans are increasingly using REITs as a way to complement their private real estate investment,” says Kurt Walten, Nareit’s senior vice president, investment affairs & investor education. For example, Dutch pension services provider APG, one of the largest investors in real estate worldwide uses a fully integrated strategy combining REITs and non-listed real estate to build and manage a portfolio of global real estate investments. Currently, its portfolio is split about 60-40, with the majority in private real estate and the balance in listed REITs.
Although average pension fund allocations to real estate hover at around 10% of the total investment portfolio, Nareit analysis suggests the optimal allocation is 15%. Nareit also contends that pension plans can benefit from a minimum investment ratio of at least 25% of their real estate allocation to public REITs. That translates to significant opportunity for growth in REIT investments across the pension fund industry.
“For a lot of pension plans, putting an allocation into REITs doesn’t have to mean taking an allocation away from private real estate,” Worth adds.
