Be Active Redux

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Dedicated REIT Managers Continue to Outperform

Five years ago, we penned a paper analyzing the performance of active global REIT managers, and found that over ten years of investing, the “median manager consistently outperformed passive benchmarks, typically above and beyond standard institutional account fees.”

At that time, REITs had also delivered superior performance to many asset classes. With 2020 performance demonstrating total returns of 45.6% for US REITs as measured by the FTSE NAREIT All REIT Index [see index glossary] and 27.2% for Global REITs represented by the FTSE EPRA NAREIT Developed Index [see index glossary] , we find ourselves in a similar environment and facing the perennial question of active or passive investing.

Proponents of passive investing claim that there is no free lunch in an efficient market, and for every outperforming investor, there is a corresponding underperforming one. That is, after the deduction of management fees and buy/sell costs, a typical investor is, on average, underperforming market benchmarks. Academic research varies widely on this point, generally leaning on the theory of efficient markets for large-cap liquid asset types such as S&P 5001 but toward active management in niche sectors such as emerging markets, small caps and real estate [see index glossary].

REITs are well-served by active management via sector specialization and information asymmetries between public and private markets

Philosophically, we differ from the efficient markets hypothesis for REITs. We believe that REITs are well-served by active management via two key themes – specialization in an under-researched sector and information asymmetries between the two markets for commercial real estate.

The first reason centers on the idea of specialization. The phrase “jack of all trades, master of none” applies to managing investment portfolios. When real estate became its own sector within the GICS classification system [see index glossary] , it became the 11th sector for generalist investors to cover. The investment universe is broad and varied for generalist equity investors. In contrast, REIT dedicated managers can demonstrate their specialized expertise and deep knowledge of the real estate investment landscape, particularly in small-cap companies with limited sell-side coverage.

Being specialized experts in real estate ties directly to the second reason that REIT-dedicated managers have, for the most part, consistently outperformed passive benchmarks: the tale of “two markets” for real estate investing. This tale of two markets is unique to real estate and allows REIT managers the opportunity to do the in-depth research required to identify alpha opportunities. REITs, while owning some of the highest quality properties around the globe, are still a minority owner in the massive stock of commercial real estate that is primarily owned and transacted privately. Dedicated REIT managers born out of the private market have expertise and focus, allowing them to immediately access detailed and oftentimes proprietary data in order to analyze the valuations, operating trends, and inefficiencies in the private markets that could impact REIT assets. Over the last five years, this information advantage has evolved with a rapid increase in emerging, alternative real estate asset types such as data centers, senior housing, medical office, and student accomodation—where both the private and public markets are still deepening their knowledge to better understand these growing niche sectors.

Analyzing 20 Years of Active REIT Investing

In testing our hypothesis, we analyzed the rolling three-year annualized returns of US and Global REITs from the beginning of 2001 to the end of 2021 utilizing eVestment, LLC data.

For US REITs, we identified between 48 to 61 actively-managed strategies operating during the period. In order to avoid survivor bias, these include terminated strategies. We found a consistent level of outperformance before fees of 1.10% for the median manager over all time periods.

We further subdivided the data into 95th, 75th, 50th, 25th and 5th percentiles to determine at what point an active REIT manager underperforms.

The chart above indicates that 3rd quartile managers have been at or around benchmark returns. The median manager has extended this outperformance to 2.57% above their selected benchmark in recent years.

The second chart below tracks the number of strategies reported to eVestment and the percentage that are exceeding their benchmark. This performance has moved from 38% in 2003 to 84% in 2021, with an average over the 20 year period of 58% of all strategies beating this hurdle.

We then undertook the same analysis for Global REITs.

While there are more strategies in this category, many have shorter track records. Nevertheless, according to eVestment data, the median manager has, since 2005, consistently exceeded its selected benchmark by an average of 1.29%, and over time, rising to 3.45% in 2021. Similarly, since that time, 3rd quartile managers have delivered around benchmark returns before fees.

The hit rate of Global REIT managers is similar to the US and has shown the same pattern of increasing to a high of 85% in 2021.

Conclusion

Active REIT managers have consistently been able to identify and participate in alpha opportunities

In revisiting our initial research, we have found that recent performance data for listed REIT strategies shows that active management has consistently outperformed benchmarks and, as a result, passive managers. Our findings remain consistent in that specialization of research in one sector, and the abundance of data from the private market are two reasons why active REIT managers have consistently been able to identify and participate in alpha opportunities. In an environment of increased specialization and evolution of the REIT market into new jurisdictions and property types, we further believe that the outlook for active management in the sector is positive.

Index Glossary

Indices shown are for informational purposes only and do not include fees. Indices are unmanaged, not subject to management fees and cannot be invested in directly.

The FTSE EPRA NAREIT Developed Index is designed to track the performance of publicly listed real estate companies and REITS worldwide, containing eligible constituents from Developed markets as classified by FTSE Russell based on the nationality rules for FTSE EPRA NAREIT Global Real Estate Index Series.

The FTSE EPRA/NAREIT All REIT (Europe Public Real Estate Association/National Association of Real Estate Investment Trusts) Index is a total return performance index of all equity REITs tracked by FTSE EPRA/NAREIT.

The S&P 500 Index is an unmanaged index generally considered to be representative of the large cap segment of the market.

The Global Industry Classification Standard (GICS) is a 4-level classification system developed in 1999 by MSCI and S&P Dow Jones Indices to categorize companies traded on public stock exchanges.

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