How Global Real Estate Can Provide Investors a Unique Investment Opportunity

In this interview, Greg Kuhl, CFA, Portfolio Manager of Janus Henderson Global Real Estate Fund, explains how various trends are creating global investment opportunities and the potential for higher income with lower volatility than general equities.

In what types of real estate does the Fund invest?

Most of our investments are publicly traded companies that have chosen to be taxed as real estate investment trusts (REITs). As REITs, they meet certain qualifications that make them exempt from corporate income taxes. Because they aren’t facing the double taxation that most public companies do, they can pay out a relatively higher dividend to shareholders. Our strategy is global, so we invest around the world.

How does the Fund deliver both capital appreciation and current income?

The companies we invest in derive income from long-term leases to tenants. Most of the leases have annual rent escalations that are linked to inflation, meaning the rent typically increases by approximately 2% per year. We believe that’s a very solid foundation for current and growing income.

Changes in overall rental markets over time are what drive capital appreciation. While a lease may be escalating at 2% per year, when a lease term ends and the tenant renews, rent may increase 15%–20% in strong locations. Capturing that incremental cash flow powers capital appreciation in real estate.

What trends are having the greatest impact on commercial real estate here in the United States and internationally?

The biggest trend centers on retail real estate worldwide. Most existing retail real estate was built for a time when people weren’t shopping online. Today, brick and mortar stores are too big, and there are too many of them, leading to too much supply in the face of decreasing demand. This works against retail landlords via increased vacancies, falling rents and falling asset values. Over the last three years ending 6/30, our Fund’s retail real estate allocation is underweight compared to the benchmark’s, which has been advantageous for our performance.

Alternatively, industrial and logistics real estate is a booming business with strong investment opportunities. Due to the growth of online shopping, a great deal of inventory is being stored in warehouses to facilitate shipping goods directly to consumers. There hasn’t been significant supply growth in warehouses globally, so rents, asset values, cash flows and occupancies are increasing. We’re in the early days of retailers investing in their supply chains, so we anticipate this growth will continue for the foreseeable future.

Demographic shifts impact REITs as well. For example, manufactured housing communities that serve younger retirees are benefiting from a wave of individuals entering their 60s whose housing needs have changed. The communities owned by the public companies we invest in are fully leased and able to grow rents. Additionally, multi-family apartment REITs provide a way to capitalize on the trend of millennials renting longer, often in urban areas, while REITs renting single-family homes are capturing demand as more millennials begin having children.

What are you looking for as you evaluate stocks?

The traditional way to evaluate real estate and REITs is to value the buildings they own and use that value to estimate what the stock is worth. But we think REITs are much more dynamic than just a collection of buildings, so we recognize them as businesses and underwrite them accordingly. This translates into greater focus on cash flow growth potential than our competition. We seek to invest in companies that have valuable buildings, can grow their cash flows and whose stock is attractively priced relative to those characteristics.

Have economic and market conditions been favorable for REITs? Do you see those conditions continuing?

On a relative basis versus general equities, we believe there are three things that have helped REITs over the last 12 to 18 months and should continue to do so.

First is slowing growth in general equities. REITs look better in this environment because their growth tends to be stable, as their underlying cash flows are derived from long-term contractual leases.

Additionally, increased risk tends to help sentiment toward REITs. And recently, we’ve seen an uptick in risk in the capital markets and general environment.

Finally, dovish central banks generally mean lower interest rates, which should correlate to higher asset values in real estate. This is especially true over the long term, assuming lower rates are sustainable.

Why might investors consider adding a global investment to their portfolios?

From the perspective of a U.S. investor, going global offers diversification. Global REITs tend to have lower correlations to global stocks and bonds, meaning different drivers of returns and risks for client portfolios.

When building a portfolio, going global gives us a broader universe of opportunities. For example, of the approximately 500 companies in our global universe, only about 200 are in North America.

What role can the Fund play in a portfolio, particularly for investors approaching or in retirement?

The Fund has the potential to provide higher current income and lower volatility than general equities yet with similar total returns. For those reasons, it may be attractive to aging investors looking for income and a more defensive equity position. And, of course, it offers investors who may be overweight in domestic equities a way to diversify globally while potentially reducing overall portfolio risk.

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