​The Global Property Equities Team, headed by Guy Barnard and Tim Gibson, discuss the various merits of investing in listed real estate investment trusts (REITs) compared to unlisted real estate. While listed REITs may experience short-term price swings unrelated to underlying real estate fundamentals, the combination of short-term price volatility and daily trading liquidity offers  an opportunistic advantage for the active investor.

All forms of real estate ownership are not created equal. Investors can access commercial real estate, the third largest financial asset class, through non-traded REITs, interval funds offering daily subscriptions with quarterly redemption windows, private core and opportunistic funds (closed end funds with limited liquidity), and publicly traded, listed REITs. While unlisted real estate funds entice investors by targeting high yields, comparatively low short-term volatility, and exclusive access to well-known private managers, these funds also entail illiquidity, opaque financial disclosure, and potential conflicts of interest. Listed REITs are professionally managed property companies that trade daily on major stock exchanges, offer regulated and transparent financial disclosure, and are incentivised to create shareholder value on a perpetual basis.

Specialised property types including industrial, data centres, mobile phone towers, age restricted manufactured housing, and self-storage are sectors with more favourable long-term growth outlooks compared to traditional, core property types. Specialist property is also more easily accessed through listed REITs than via the direct property market. In addition to their structural superiority, between 1998 and 2016 (refer to the following chart), listed REITs have historically outperformed unlisted real estate by over 2% per annum. (Source: Beath, Alexander and Flynn, Chris. CEM Benchmarking. ‘Real estate performance by implementation style’, 1 December 2018). Typically the best performing and most investor-friendly structure within real estate, listed REITs can offer valuable diversification benefits and superior risk-adjusted total returns for investors. Historically listed REITs have outperformed unlisted real estate Source: Beath, Alexander and Flynn, Chris. CEM Benchmarking. ‘Real estate performance by implementation style’, 1 December 2018. * Past performance is not an indicator of future performance. Net geometric average return is the compound average of fund-weighted averages. Returns are net of all direct investment management expenses. Facts do not cease to exist because they are ignored A hallmark of unlisted real estate funds is the promise of relatively lower volatility. In arriving at quarterly reported valuations, typically only around 25% of unlisted real estate fund holdings are appraised. These appraisals rely on historical comparable transactions and mark-to-model internal estimates, are backward-looking and there can be conflicted approaches to valuation. It should come as no surprise that valuations that exclude some 75% of holdings often result in low reported volatility for unlisted real estate funds. Since managers of unlisted real estate funds collect fees based on reported fund values and market their products on low volatility, prospective investors should be wary as the funds may be incentivised to report elevated, smoothed values. In contrast, exchange-traded REITs are priced every day by thousands of unaffiliated equity market participants. As listed stocks, REITs undergo short-term price fluctuations, yet research by CEM Benchmarking reveals that unlisted real estate and listed REITs are 90% correlated when unlisted returns have been appropriately calculated by addressing their lag in reported values.  When the unreported volatility of unlisted real estate is adjusted for, listed REITs and unlisted real estate behave similarly. Characteristics of listed REITs versus unlisted real estate Source: Janus Henderson Investors as at 13 June 2019. Annualised return from 1998 to 2016: CEM Benchmarking. ‘Real estate performance by implementation style’, 1 December 2018. Past performance is not an indicator of future performance. Net geometric average return is the compound average of fund-weighted averages. Returns are net of all direct investment management expenses. Opportunity in volatility, optionality in liquidity Redemption windows for unlisted real estate products can range from monthly to quarterly, but amounts are often limited to only circa 5% of capital and are further subject to approval by fund managers. While providing full liquidity at the discretion of investors, listed REITs occasionally experience short-term price swings unrelated to underlying real estate fundamentals. This provides opportunities to investors to buy high quality real estate at discounted prices. The combination of short-term price volatility and daily trading liquidity represents a unique, opportunistic advantage only available via listed REITs. Underappreciated growth While an important characteristic of commercial real estate is its income generation, the listed REIT sector has illustrated consistent historical earnings growth supporting higher distributions over time. The sector’s growth profile has been driven by property firms serving markets underpinned by persistent long-term tenant demand including mobile phone towers, data centres, self-storage properties, and age-restricted manufactured housing. While the leading firms across these specialised sectors are listed in the public market, unlisted funds tend to include mainly slower growth, less compelling asset types such as office and retail property. Although these property types may be easier to acquire and manage, their growth profiles are likely to meaningfully lag those of specialised listed REITs. Since specialty property firms now represent over 30% of the listed REIT sector, investors are much more likely to find an attractive combination of growth and income in the public, rather than private, real estate market.

For investors seeking efficient access to commercial property without the shortcomings of unlisted real estate funds, the Janus Henderson Global Property Equities Strategy offers investors a ‘best ideas’ portfolio targeting 50 to 60 of the most compelling property stocks across North America, Europe, and Asia. The Global Property Equities Team believes the companies they invest in own high quality real estate, are led by excellent management teams, and have the potential to offer stable current income with a consistent growth runway. The Strategy’s managers also exploit the natural advantages of listed REITs by aiming to acquire real estate stocks at attractive values and taking advantage of market liquidity to optimise portfolio construction.