Get Real, Estate
Just as diversification through global equities and bonds is a prudent approach for more conservative investors, we believe that deepening this spectrum to include global real estate securities may enhance risk-adjusted returns, minimise volatility due to the lower correlations with other asset classes, and create a yield uplift on the aggregate portfolio level.
Real Estate Investment Trusts (REITs) were first structured in the United States in 1960 by Congress to facilitate and democratise investment in large-scale, diversified portfolios of income-producing real estate or real estate-related assets, in a tax-advantaged structure.
According to the United States Securities and Exchange Commission, a REIT is defined as a corporation which operationally derives income and capital growth through a professionally managed investment portfolio of real estate assets. To additionally qualify as a REIT, a company must also distribute at least 90% of its taxable income to shareholders annually in the form of dividends. This rate was reduced from 95% in 2001. The payout ratio functions as a special tax deduction, with REITs that elect to pay out the entirety of taxable income therefore owing nil corporate tax.
Globally REITs have lower penetration and development outside of Australia, the United States and the Netherlands, where legislative codification occurred during the 60s and 70s. Regulatory approval is however, now spreading worldwide and investors should capitalise on the fact.
Figure 1 - Penetration and acceleration of the REIT market
Demographics and Income Focus
Historical growth and penetration aside, we believe that an ongoing emphasis will still be placed on developed economies and markets where demographic forces require the need for capital preservation and income-producing investments. Figure 2 contrasts the yield spread of various assets domestically and globally. Global REITs in developed nations provided a yield differential of c. 2.3% during the Covid-19 pandemic over 2020 when earnings guidance was suspended on a large scale and uncertainties were immense. REITs, with their emphasis on dividends, professional management and structural requirements, provide a natural opportunity for clients to participate in total returns driven by both income and capital appreciation.
Observing economic indicators, such as vacancy rates shown in Figure 4, also strengthens the argument for positive tailwinds offshore that are now able to be participated in through a liquid and diversified investment vehicle. Homeowner vacancy rates have been declining in the United States for a number of years, even prior to the pandemic, which suggests a fundamental supply-demand imbalance. The time series residential vacancy data collated by The U.S. Census Bureau reveals what share of owner-occupied housing units are vacant and for sale. This could suggest a serious housing shortage, with the combination of fewer homes for sale and record low interest rates driving up property prices.
Figure 2 - Yields on domestic and global asset classes
Figure 3 - Asset class 25 year total return composition
Figure 4 - United States homeowner vacancy rate
Unlike the resulting by-product of maturity within the Australian REIT sector, Global REITs produce less concentration risk in both names and sectors. As shown in Figure 5, the top 10 Australian REITs, on a market capitalisation basis, constitute ~80% of the S&P/ASX 300 AREIT Index. Global REITs, meanwhile, can provide clients with underlying access to more than 330 businesses, where the top 10 holdings account for only around 26%. Accessing important sub-sectors with secular growth potential, such as residential, data centres & towers and healthcare can also help in harnessing foreseeable tailwinds.
Lower correlation to other asset classes also provides for diversification benefits within overall client portfolios. As shown in Figure 6, real estate exhibits the necessary low return correlations between equity markets and other region property markets. This is particularly important when considering globalisation and trans-national dependencies that have grown over the last few decades. Real estate markets continue to exhibit idiosyncratic price movements that are location specific and contingent on different property, economic and monetary fundamentals. This can be further harnessed through the various subsectors. Equities and fixed income, meanwhile, pose the risk of rising correlation, especially when noting that this dynamic has become largely positive and increasing since the global financial crisis.
Figure 5 - Comparison of holdings and sector allocation
Figure 6 - Correlation matrix of regional property markets
Resolution Capital is an active G-REIT manager with a 26 year track record, where since inception alpha of the Fund is 2.8% p.a. The Resolution Capital Global Property
Securities Fund is now accessible as a listed active ETF under the ASX ticker RCAP.
Click below for a copy of the full 27-page Bell Potter ETF report for February, which contains flows, returns, a complete list of available Exchange Traded Funds and a detailed look at RCAP.
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