It’s no longer simply about passing the family homestead to successive generations. The number of methods, sectors, styles—and yes, products—now available make real estate investing exponentially more complicated, but exponentially more lucrative when done right.
Real estate investment trusts (REIT), in particular, are a proven and critical diversifier for better risk-adjusted returns, especially in periods of increasing stock and bond market correlation.
It therefore often earns them a spot in the alternative investment sleeve of the portfolio, which is fine, but does real estate perform better as a core allocation?
Charlie Wenzel says yes (emphatically), and believes it also belongs in retirement plan investment menus.
The senior vice president and head of defined contribution for REIT powerhouse Cohen & Steers points to the asset class’ track record, diversification potential, liquidity and simplicity, all of which align particularly well with the long-term investment objectives 401k participants require.
Indeed, “To help address the need for broader diversification, many investors have turned to REITs and other real estate securities,” a recent company-produced white paper noted. “Since 2005, global assets under management in listed real estate portfolios have nearly tripled, benefiting from increasing awareness of the historical benefits of REITs and a broader trend toward real return strategies.”
Would any 401k advisor and plan sponsor that doesn’t take a hard look at the space therefore find themselves in fiduciary trouble?
Wenzel diplomatically demurred, adding that it’s a question for Fred Reish, but he and Evan Serton, senior vice president and a member of Cohen & Steers’ Portfolio Specialist Group, still had plenty to say about the proper role of REITs in retirement saving, and how advisors, sponsors and (most importantly) participants benefit from their inclusion in the portfolio.
Q: Let’s get right to it—should alternatives be a core or alternative allocation in the retirement portfolio?
Wenzel: I’m not sure you’re aware, but real estate became the eleventh sector of the S&P 500 two years ago this month (as its own sector, since it was blended with financials before that time). So, does that make it a core asset class? Not necessarily, but it certainly brought some light to the asset class.
We took a look at equities, fixed income and REITs. Commercial REITs are the third largest asset class in the world, with $16 trillion in assets. Close to $2 trillion of that is publicly traded REITs.
We therefore believe real estate should be considered a core asset class, and there are advisors that do believe that, whether it’s their wealth management models or their retirement plans. There are many that are high-end and say, “Why wouldn’t I use REITs? It’s one of the best performers over the past 15 years, and I use it in every plan and I recommend it in every model.”
Of course, there are others that say, “No, I use core asset classes only,” and they see REITs as either satellite or in the “alternatives” or “specialty” bucket. I’m going by my recordkeeper background, but when you see these fund lists, we tend to fall into that specialty or alternative bucket, so it’s a mindset.
Serton: Part of why we believe real estate is a core asset class is that it offers something that equities and fixed income don’t.
When you look at the long-term performance of real estate securities—10, 15 or 20-years plus—what you’re getting is something very close to the performance of the actual commercial real estate market, which has a much different return trajectory from equities or fixed income.
So, anyone looking to diversify away from traditional asset classes would be well-served by an investment in REITs. You’re not necessarily getting that in the short-term, say three or six months or even a year. In that case, you can get return series that are much more like equity markets, which contributes to some of the misperceptions between listed real estate and private real estate.
However, over longer periods of time with listed real estate, you get the return series of the commercial real estate market in the United States.
Q: What kind of an education effort do you think it’s going to take to change the mindset you mentioned?
Wenzel: In the white paper, we illustrate that by adding REITs, the volatility remains the same or similar, yet there’s better risk-adjusted return. It’s one piece we’re showing to advisors that have some concern about volatility.
The other is with educating the participant. When people think about REITs, they think about the mall; they think about shopping centers. They don’t think about cell towers and data centers, and these are high-income producing, well-known, and “used every day in your life” REITs. Wouldn’t you like to own a few [investments] within a portfolio with dedicated allocations to them?
We’re educating advisors who are educating investment committees, and who in turn are educating participants. Their current target-date fund might have zero allocations to these, and their plan might have none. It’s something they might want to know.
Serton: I think the education effort would be enhanced by explaining to investors that our REIT portfolios are mirroring some of the larger trends we are seeing in the commercial real estate world.
We’ve been increasingly negative on retail commercial real estate for all the reasons you can imagine. As Charlie said, we’ve ventured into, and in some cases are overweight, the data center and cell tower properties that are in many ways the beneficiaries of what’s causing so much distress among the conventional retail property owners.
Anyone who is paying attention to the trends both in personal commerce and in the commercial real estate world will find it very intuitive to realize that an investment in REITs is not just an investment in office buildings or apartments, but increasingly in a more digital infrastructure marketplace.
I think, to the extent that we can tout that message and have our partners tout that message, it’s something investors will increasingly embrace.
Q: What about the REIT presence in target-date products?
Wenzel: Callan did a survey two years ago of high-end 401k advisors and asked them about a whole list of asset classes, and which they use in their core lineup. I don’t know if this helps us or not, but only 40 percent of advisors said, “Yes, I use REITs in my core lineup.”
And so, those people believe it’s a core asset class, but at that time there was 60 percent that either said, “No, I don’t use it in my core lineup” or “I believe I get it in my target date.”
I can tell you Vanguard has no dedicated allocation to REITs in their target date, and I can tell you American Funds has no dedicated allocation to REITs in their target date.
However, I can tell you other firms like J.P. Morgan and T. Rowe Price do have allocations to REITs. And those allocations change every quarter from 1 to 11 percent depending on who they are, which is interesting.
So, for those that say, “I assume I get it in my target date,” we’re educating advisors on that exact topic.
The next question might therefore be, “Are you aware of the amount of real estate or real assets in your target date series?”
If you’re using a target date that might be underweight or zero, maybe you should consider these as a standalone investment option in your plans.
You said that what you do mirrors certain trends in the larger marketplace. What research process does Cohen & Steers employ to identify some of those trends?
Serton: We have a team of analysts. We have one of the largest teams of investment professionals dedicated to the management of REIT portfolios. We have a team of seven analysts whose job it is to do fundamental work on individual companies.
So, these analysts are visiting company management. They’re touring assets owned by the companies under their coverage. They are frequently talking to the tenants of those properties. And they are arriving at quantitative estimates of value. They’re creating a net asset value estimate, and an estimate of value based on the future cash flows of the company.
That’s very labor-intensive work as you can imagine.
Wenzel: A key point is that once we’ve got that advisor or 401k team as a user of REITs, we’re then comparing passive versus active when using REITs.
We’re talking about the case for active right now. If you’ve looked at surveys of what asset classes should be considered for active versus passive, you’ll find that more than 50 percent of advisors highly suggest using active when it comes to REITs (versus large-cap equities, which might be a lot lower than that).
Serton: Part of the reason is that if you look at the performance of the individual property types within the listed REIT market in any calendar year, you will see an enormous divergence in performance between the best performing and the worst performing REIT property type.
Just last year, REITs were up only 5 percent overall. But the best performing REIT property types were data centers (up 27 percent) and the worst performing property type was shopping centers (down 11). That’s an enormous spread. If you are owning only the index, you are getting a lot of the bad with a lot of the good.
With more than 20 years serving financial markets, John Sullivan is the former editor-in-chief of Investment Advisor magazine and retirement editor of ThinkAdvisor.com. Sullivan is also the former editor of Boomer Market Advisor and Bank Advisor magazines, and has a background in the insurance and investment industries in addition to his journalism roots.
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