Real Estate Funds Have Been a Balm in a Stinging Market

anastasios pallis

After years of being overshadowed by the likes of Apple and Alphabet, real estate funds have lately edged ahead of the overall stock market by betting mainly on old-fashioned assets like office buildings, malls and warehouses.

In the fourth quarter, when the stock market really started to jitter and slide, the S&P 500 sank 13.52 percent, including dividends, but the FTSE Nareit All Equity R.E.I.T.s Index, a leading index composed of publicly traded real estate investment trusts, lost only 6.1 percent. For all of 2018, as the S&P 500 lost 4.4 percent, including dividends, the FTSE Nareit index lost only 4 percent.

So it goes for this stalwart, if stodgy, sector: Real estate can often chug along when other sectors start to sputter. For that reason, a real estate mutual fund or exchange-traded fund may help buffer an otherwise diversified portfolio from some of the stock market’s swings. In addition, it’s an entree to investing in commercial real estate for someone who can’t afford the Empire State Building (which is owned by a R.E.I.T. named Empire State Realty Trust).

R.E.I.T.s are property owners whose shares trade on stock exchanges. They can own a variety of real estate, ranging from the obvious — those office buildings, warehouses and shopping centers — to the more obscure — data centers, cell towers and even timberlands. Some own residential rental properties or finance home purchases, but those account for only about one-fifth of the overall R.E.I.T. market, according to the National Association of Real Estate Investment Trusts.

A share in a real-estate mutual fund or E.T.F. is “effectively a hybrid of debt and equity,” said Michael J. Acton, managing director and head of research for AEW Capital Management in Boston. “The debt feature is lease payments you get from the underlying properties, and the equity feature is the right to re-lease or sell those properties.” The lease payments can provide predictability like bonds, while the property values offer upside potential like stocks.

Morningstar, the investment-analysis company, found that from 1972 through 2018, R.E.I.T.s provided a compound average annual return of 11.5 percent, compared to 10.2 percent for United States stocks. Morningstar has also found that real-estate stocks are slightly more volatile, on average, than other stocks. During the global financial crisis, real estate crashed with other stock market sectors, with the FTSE Nareit index falling 37.7 percent.

Still, real estate funds and E.T.F.s often can provide additional diversification to an investment portfolio because commercial property markets don’t usually move in lock step with stocks, Mr. Acton said. “There are leases in place, and the cash flows from those leases are already locked in.”

In 2013 research paper, Pankaj Agrrawal, a finance professor at the University of Maine, found that adding real estate to a portfolio of stocks, bonds and gold both increased the return and damped the volatility. Professor Agrrawal split the hypothetical portfolio into sixths and allocated it equally across these asset classes: United States stocks, European stocks, emerging market stocks, United States bonds, gold and United States real estate.

R.E.I.T.s must pay out at least 90 percent of their taxable income to shareholders. As a result, real estate funds can produce income in much the way bonds or utility stocks do. R.E.I.T.s tracked by the R.E.I.T. association provide an average annual yield of about 4 percent, compared with 1.87 percent for the S&P 500.

How much of a fund investor’s overall portfolio should be allocated to real estate is a question, like so many in the investment world, that’s a matter of philosophical dispute.

Matthew C. Brancato, a principal and head of the portfolio review department at Vanguard, said investors who own well-diversified index funds, like those built upon the S&P 500, may already have all the real estate they need. The S&P index includes 32 R.E.I.T.s, and together they account for about 3 percent of the index’s market capitalization.

Layering a dedicated real estate fund or E.T.F. atop a broad-based core holding would imply that an investor wanted to “express a view about real estate” — either believing that it will outperform the rest of the market or just liking the sector, Mr. Brancato said.

But portfolio managers of real estate funds say reasons beyond a fascination with bricks and blueprints might persuade investors to nudge their real estate allocations above that of broad-based index funds.

For one thing, the allocations of the marketwide indexes are arguably too small, when compared to commercial real estate’s share of the economy, said Steve S. Shigekawa, senior portfolio manager of the Neuberger Berman Real Estate Fund.

“Commercial real estate is a very large market,” he said.

Many large pension funds, which often buy commercial real estate directly, hold larger real estate allocations than that of the S&P 500, said Nina P. Jones, portfolio manager of the T. Rowe Price Real Estate Fund. “Many of them have gravitated to 10 percent of their overall asset allocations,” she said. (Ms. Jones took over her fund on Jan. 1, after the retirement of David M. Lee, who led it since its 1997 inception.)

Though real estate has performed well lately, there are, to swipe a line from the blues singer Robert Johnson, stones in its passway: Interest rates are rising, and retail real estate is being squeezed by the rise of e-commerce.

Conventional wisdom says rising rates hurt real estate. The logic behind this is simple, said Jennifer Cookke, a lecturer in the Center for Real Estate at Massachusetts Institute of Technology. “You typically have debt on a property,” she said. “So when interest rates rise, costs are higher, and that reduces profit.”

The managers of the Neuberger Berman Real Estate Fund delved into whether rates really do damp R.E.I.T.s and learned that the effect was often temporary, said Brian Jones, who manages the fund with Mr. Shigekawa. “What we found is, in periods where interest rates were spiking, the performance of R.E.I.T.s suffered,” Mr. Jones said. “But if you go six and 12 months beyond a rate spike, R.E.I.T.s shares typically recover and do very well.”

E-commerce’s effects won’t be sloughed off so easily. They can be summarized in a single name: Amazon. The online giant (and other e-commerce companies) is changing how people shop and raising questions about the need for physical storefronts.

Steven J. Buller, portfolio manager of Fidelity Real Estate Investment Portfolio, said he foresaw continued demand for bricks-and-mortar stores — just fewer of them. “There’s too much retail space in the United States — 24 square feet a person, which is twice as much as Canada,” which has the second-highest amount in the world, he said.

This country has 1,200 shopping malls alone, Mr. Buller said. “There are 400 class-A malls, and I think those will survive. The other 800? I don’t know.” Mr. Buller has allocated about 20 percent of his fund to retail holdings, and the Simon Property Group, the country’s largest mall R.E.I.T., is among his top stakes.

An investor who wants to bet on real estate must make the usual choice between actively managed funds, like those offered by Neuberger Berman, T. Rowe Price and Fidelity, and passively managed indexed offerings.

The latter include the Vanguard Real Estate Index Fund (which is also offered as an E.T.F.), the Schwab U.S. R.E.I.T. E.T.F. and the SPDR Dow Jones R.E.I.T. E.T.F.

A misconception of some investors is that they’ve already diversified their portfolio with real estate because they own a house and perhaps a vacation rental, said Mr. Jones, of the Neuberger Berman fund. That sort of ownership is a narrow bet on one or two markets, comparable to owning one or two stocks instead of, say, an S&P 500 index fund. “You don’t derive the same diversification benefit that you can get from a R.E.I.T. fund,” he said.

This article is from NYT – go to source

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