The REIT Newsletter for Advisors • Summer 2021
Strong Fundamentals Propel a Rebound for REITs
Following the challenges of 2020, leading real estate fund managers expect the REIT sector to regain its stride in the second half of 2021, rebounding from social and economic upheaval triggered by the coronavirus pandemic. The previous year saw a 5.12% decline in total returns for the FTSE Nareit All Equity REITs Index, but several factors are expected to support the anticipated upturn, including the COVID-19 vaccine rollout, low interest rates, and attractive pricing within those sectors that saw the most negative impact from the pandemic.
Advisor Access spoke with five fund managers about the opportunities and challenges they anticipate in the second half of 2021. Those managers are:
- Keith Bokota, portfolio manager, U.S. REIT Strategy, Principal
- Brian Jones, portfolio manager, Neuberger Berman Real Estate Team
- Lisa Kaufman, CEO and portfolio manager, LaSalle Securities
- Jeff Kolitch, portfolio manager, Baron Real Estate Fund and Baron Real Estate Income Fund, BaronFunds
- Jason Yablon, senior portfolio manager, Cohen & Steers
Advisor Access: After a year in which REITs underperformed the broader market, what do you see for 2021?
Keith Bokota: Overall, I have a favorable outlook. We saw a nice benefit from the vaccine announcement in November, and I think that increases confidence in forward economic recovery and the ultimate return to normalcy.
We view the low interest rate environment as supportive of REITs. Also, when we look at valuation levels, relative to bond markets or fixed income, we believe there’s a strong case for forward returns.
Brian Jones: We think there will certainly be opportunities for real estate stocks to perform well in 2021. A number of sectors were severely impacted by the pandemic. As the rollout of vaccines continues and economic activity improves, and we return to more normal lives, some of the sectors, such as retail, hotels, and office—to a degree—may begin to see a recovery in their fundamentals. That could help lead to better performance within the REIT asset class as we move through 2021.
Lisa Kaufman: REITs finished 2020 with a strong rally, but ended the year well below year-ago levels. At the same time, financial conditions have eased materially over this time frame, and fundamentals are bottoming, or have bottomed, in most sectors. We believe the combination of repricing that’s already occurred, ultra-low interest rates, and improving fundamentals provides a very strong setup for REIT returns this year.
Jeff Kolitch: We are optimistic about the prospects for REITs. Much of real estate lagged in 2020, in part because the business models of several segments are based on the assembly of people. We expect this headwind to begin to reverse in the year ahead. In addition, several segments of public real estate are attractively valued relative to equity, bond, and private real estate alternatives.
We think real estate is at the doorstep, or the very early stages, of a new real estate cycle. REITs, and real estate generally, should be one of the prime beneficiaries of an improvement in economic conditions if, in fact, a large swath of the population is vaccinated over the course of 2021.
Jason Yablon: Just as REITs were disproportionately impacted by the pandemic in 2020, we also believe they’re poised to recover as vaccines get distributed across the country in 2021. We also think REITs tend to perform well in the early stages of a business cycle, where fundamentals are improving, and the Federal Reserve remains accommodating.
AA: Which commercial real estate sectors do you think will perform the best in 2021?
Kolitch: We believe many of the laggards of 2020 will generate solid returns in the year ahead. This group may include certain apartment, office, retail, hotel, and gaming REITs. Data center REITs are benefiting from secular growth in the outsourcing of information technology, increased cloud computing adoption, and the growth in U.S. mobile data and internet traffic.
Wireless tower REITs are positioned to grow for several years as the demand for data-intensive devices accelerates and new wireless technologies emerge. Industrial REITs should continue to benefit from robust warehouse demand, in part due to broader e-commerce needs.
Bokota: Our favorite sector for 2021 is residential—both single-family rentals and manufactured homes. We’re seeing increasing levels of demand, record-high occupancy levels, and strong pricing power as people look to get more space. They’re also still trading at very reasonable valuations. Other sectors to highlight would be wireless infrastructure and industrial, as we see continued strong tenant demand.
Jones: The single-family rental sector has benefited as young families, in particular, are looking for more space. REITs that own timberlands and, in many cases, manufacture lumber and other wood products, have also benefitted, because their primary use is in new home construction.
Kaufman: We like the residential sectors—single-family homes, manufactured homes, apartments. We also like shopping centers, which I think is a bit contrarian today. We see good value in that sector following the underperformance of last year. We also see value in some of the sectors that have maintained pricing power and outperformed during the pandemic—cell towers, for example.
Yablon: We think fundamentals in the self-storage business are re-accelerating quite meaningfully as people continue to move around the country, repurpose their spare rooms, and move belongings into self-storage. We also have a view that a lot of the sectors negatively impacted by the pandemic will begin the recovery story. We think gaming, healthcare, high-quality malls, and net lease are attractively valued right now, but they’re also vaccine-recovery stories.
AA: Which sectors do you feel will face the biggest challenges in the coming year?
Jones: I would be cautious on hotels and office. For the hotel sector, travel is still very depressed, particularly business travel. We think that even as the vaccine rolls out, corporations will be conservative about adding to their travel budgets. The story on leisure travel is a little more constructive in that many families haven’t had traditional vacations for the better part of a year, so we could see strong pent-up demand for leisure travel in summer.
As it relates to office, the work-from-home dynamic and the good productivity that corporations have been able to maintain may encourage them to embrace aspects of remote work even when the pandemic recedes. If that is the case, this could serve as a moderator of office demand.
Kaufman: We think retail and office will be the most challenged. Lodging also faces a tough road to recovery. We’re expecting positive operating income growth, though, for all sectors by 2022. That includes office, lodging, and retail, but the rate of growth will lag for the office sector.
Yablon: We continue to think that office will struggle. Even as the country becomes vaccinated, companies are thinking about their space needs and how to fulfill the needs of their employees. I think there will be a structural shift, where the percentage of people working from home will increase pretty dramatically, even in a post-vaccination world.
AA: What are some of the key potential risks or headwinds to REIT performance in the coming year?
Bokota: A couple of areas we’re watching are the vaccine and the return to normalcy, as well as the continued aggressive stimulus, both fiscal and monetary. If we saw any cracks in those positives, I think that would be negative for all investment markets, including REITs.
The other thing to keep an eye on are interest rates. REITs have sometimes had poor relative performances if rates moved up too far too fast, even if rates are moving up because the economic environment is improving.
Jones: One thing to pay close attention to is the pace of recovery within real estate markets as the pandemic recedes. We would expect the sectors hurt by the pandemic will begin improving in the second half of 2021, but there are certainly open questions about the pace of that improvement, as well as some questions as to whether the pandemic has led to changes in behaviors that will endure even as the risks from the virus recede.
Kaufman: I think the biggest risk for REITs remains the virus. We’re very optimistic that science has prevailed here. We see the vaccines coming, but there’s risk that the process could be derailed by mutations of the virus or issues with the rollout or even the long-term effectiveness of the vaccines. In all likelihood, there will be some bumps along this path to recovery, and it will be uneven. We think some of the behavioral changes that have occurred during the pandemic may endure, and those will impact certain geographies or certain sectors longer than others.
Kolitch: A further reopening of the economy is critical to an improvement in occupancy, rent and cash flow growth, and return performance for several real estate categories. This will not happen overnight, but perhaps over the course of 2021 into 2022. If interest rates spike, certain real estate companies and segments could face headwinds and lose their relative appeal.
Yablon: Vaccine distribution is a key concern. We’re focused on virus mutation, and whether that will change the efficacy of vaccines. Separately, some people consider higher interest rates a risk, but from our perspective, if it is driven by improving economic activity, REITs can perform well in that environment, certainly on the back of a return-to-normal trade in a post-pandemic world.
AA: Thank you all.