Are Publicly-Traded REITs Real Estate or Stocks?
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Bailard Research
Are Publicly-Traded REITs
Real Estate or Stocks?
It Depends on Your Investment Horizon
(And Who Wins: Public or Private Real
Estate?)
Ronald W. Kaiser, CRE
Henry S. Newhall
Bailard, Inc., November 2013
PU B LIC REITs WI N?
REIT pundits are currently declaring publicly-traded REIT managers the clear
winner over those that manage private real estate funds for institutional in-
vestors. In doing so, they argue that NCREIF’s publication of the National Fund
Index - Open-end, Diversified, Core Equity (NFI-ODCE) now allows analysts to
compare the performance of roughly similar public and private real estate port-
folios in terms of property mix and leverage over a long-term period (data since
1977). The results are shown in Figure 1 on the next page. At first glance, public
continued on page 2bailard research
FIGURE 1 F IGU RE 2
Public vs. Private Real Estate: Who Wins? Public vs. Private Real Estate: A Fairer Look at Who Wins
NAREIT vs. NFI-ODCE (1978 – 9/30/13) NAREIT vs. NFI-ODCE (1993 – 9/30/13)
128 8
64
Total Cumulative Return
Total Cumulative Return
32
4
(1978=1)
16
(1993=1)
8
2
4
2
1
1
NAREIT NFI ODCE*
NAREIT NFI ODCE*
*Lagged 4 quarters *Lagged 4 quarters
Sources: NAREIT, NCREIF Sources: NAREIT, NCREIF
real estate (as measured by the NAREIT index), ap- 1977 to $9 billion by 1991), that generally only pri-
pears to win.1 vate individuals invested in REITs. As a result, REITs
In Figure 1, note that the NFI-ODCE data are shown regularly traded at stock market values of 20% to
with a four-quarter lag to the NAREIT data, as it is 40% below their underlying estimated property val-
generally accepted that public REIT prices tend to ues. Institutional investors were not players until
look ahead to future property market returns— the REIT IPO boom in the early 1990s led to enough
thereby acknowledging the existence of the same market capacity to allow institutions to trade. The
forward-looking principle that applies to public resulting “Modern REIT Era” is generally accepted to
stock market prices in general. have begun in 1993. If we wait until 12/31/92 to start
the performance comparison, things look a lot dif-
ferent, as shown in Figure 2.
SKEWED DATA GIVES MISLEADI NG RESU LTS
In addition, the ending date of the analysis may also
It does not take very much digging to find that be somewhat biased in favor of public REITs. Given
Figure 1 is a misleading picture. In particular, the low interest rates and healthy appreciation, the re-
starting date of the analysis leads to a result that is cent environment has been favorable for more high-
greatly biased in favor of public REITs: ly levered vehicles and, as mentioned below, public
The 12/31/77 starting date provided an unusually low REITs tend to carry more leverage than ODCE funds.
entry point for REIT investors. During the 1970s and While difficult to quantify, this at least partially ex-
1980s, the NAREIT universe was so small (ranging plains why the recovery in public REIT share prices
from $1.5 billion in total market capitalization in have outpaced ODCE since the trough.
1
The NFI-ODCE, short for NCREIF Fund Index - Open End Diversified Core NOBODY WI NS
Equity, is the first of the NCREIF Fund Database products and is an index
of investment returns reporting on both a historical and current basis Given the above, over the long run, both methods of
the results of 31 open-end commingled funds pursuing a core investment real estate investing appear to give roughly similar
strategy, some of which have performance histories dating back to the
1970s. The NFI-ODCE Index is capitalization-weighted and is reported gross
returns. While it is tempting to draw firm conclu-
of fees. Measurement is time-weighted. NCREIF will calculate the overall sions from the analysis above, the two portfolios
aggregated Index return. The NAREIT, short for FTSE NAREIT All Equity REITs
of property are different enough to prevent precise
Index, is calculated by FTSE International Limited (“FTSE”). The All Equity
REITs Index consists of 120 publicly-traded REITs. Total returns reflect rein- comparisons.
vestment of dividends.
2 © 2013bailard research
First, the average leverage in public REITs (as mea- F IGU RE 4
sured by NAREIT) has ranged from 30% to 50% since Public REIT vs. Small Cap Stocks
1992, while the leverage in the NFI-ODCE has run Cumulative Quarterly Returns (1978 – 9/30/13)
from 20% to 35%. This would indicate that REITs 128
should have outperformed due to their higher
leverage. 64
Total Cumulative Return
32
FIGURE 3
(1979=1)
16
Property Type Weights as of 9/30/13
8
NFI-ODCE NAREIT
Industrial 15.2% 6.4% 4
Office 36.7% 12.6%
2
Retail 18.1% 28.4%
Residential 25.2% 15.2% 1
Diversified* 0.0% 10.1%
Lodging/Resorts 2.2% 7.0%
NAREIT RUSSELL 2000
Health Care 0.0% 13.4%
Sources: NAREIT, Russell
Self Storage 1.9% 6.9%
Land or Other 0.8% 0.0% cap stocks, as represented by the Russell 2000 index
(dividends reinvested), since 1979. Something very
Sources: NAREIT, NCREIF
*For NAREIT, the “Diversified” category represents REITs investing in multiple
similar is going on in these two universes!
property types.
Thus, it appears that the answer to “what influenc-
es REIT returns?” remains the same as in the 2002
In addition, the property type mix is probably a larg-
Bailard white paper, Public REITs vs. Private Real
er, and unknown, source of deviations in returns. As
Estate: Assessing Your Options, it depends on your
shown in Figure 3, at 9/30/13, public REITs had sub-
time horizon.
stantially less in office buildings than did the NFI-
ODCE. Office was the worst performing and most Some investors think of five years as “long term.”
volatile property type in the unleveraged NCREIF Over this term, the quarterly return correlation cal-
Property Index since 1992, while retail (the highest culations in Figure 5 show that the NAREIT index is
weighted property type in the NAREIT Equity REIT more heavily influenced by the same factors that in-
index as of 9/30/13) performed very well on a rela- fluence small cap stocks (a 59% correlation) than by
tive basis. However, we know the mix had varied, what is going on in private real estate. Even though
as NAREIT had a very large office holding in Equity we have lagged the NFI-ODCE data by four quarters
Office Properties that went private in early 2007. In to account for the forward-looking nature of stock
2003, Joe Pagliari2 published an extensive analysis market prices, there is still only a 38% to 40% cor-
of public vs. private real estate returns in which he relation with NAREIT. Ten-year data show the same
found no appreciable differences in performance findings.
when he adjusted for the varying mixes of property
types and varying leverage. FIGURE 5
Are REITs Real Estate or Stocks?
WHAT REALLY I N FLU ENCES PU B LIC REIT REAL ESTATE STOCKS
Correlation with Correlation with
PRICES? NFI-ODCE* Russell 2000
1977-2012 1992-2012 1978-2012
Before we calculate some answers to that question,
NAREIT Index -
consider the chart in Figure 4 that shows the cumu- 5-Year Periods
.40 .38 .59
lative quarterly returns for both NAREIT and small NAREIT Index -
.53 N/A .62
20-Year Periods
2
Pagliari, J., K. Scherer and R. Monopli, “Public vs. Private Real Estate Equities,” *Lagged 4 quarters
The Journal of Portfolio Management Special Real Estate Issue, Sept. 2003 Sources: NAREIT, NCREIF, Russell
© 2013 3bailard research
It turns out that 20 years is a more appropriate “long have developed methods for evaluating such rela-
term” investment horizon in order for the property tive values, but one firm, Greenstreet Advisors, has
market influences to roughly equate to those from a very long data set going back to the beginning of
small cap stocks—both at about a 60% correlation 1990, as shown in Figure 6.
since the inception of the “modern REIT era” in the In Figure 7 below, we segment all the calendar quar-
early 1990s. terly return data into seven initial valuation catego-
ries ranging from +15% overvalued to -10%.
TH E STARTI NG POI NT M ATTERS—A LOT—FOR Looking at the calculated returns to both NAREIT
I NVESTOR RETU RNS I N PU B LIC REITS and NFI-ODCE for the subsequent 20 quarters, we
Just as we saw earlier in the enhanced public REIT find the following:
returns from the undervalued starting point in 1978, • When public REITs traded at more than a 10% dis-
the starting—and ending—valuations relative to count to NAV, they substantially outperformed
underlying property net asset value is an important private real estate;
driver of return variations. A number of analysts
• When public REITs traded at more than a 10% pre-
mium to NAV, they significantly underperformed
FIGURE 6
private real estate; and
All REIT Premium/Discount to NAV
• When public REITs traded within +/-10% of NAV,
40%
they have tended to moderately outperform pri-
30%
11/1/2013
3.4%
vate real estate, which is as one would expect
20%
given the greater leverage in REITs.
10%
Where are we today? As of 11/1/13, Greenstreet’s All-
0%
REIT premium to NAV is +3.4%—not a particularly
-10%
strong signal one way or the other.
-20%
-30%
-40%
-50%
Premium / Discount to NAV Long Term Avg (3.1%)
Source: Greenstreet Advisors
FIGURE 7
The Starting Point Matters for Public REIT Returns
1990 - 9/30/13
PUBLIC REIT PREMIUM / DISCOUNT # QUARTERS AVERAGE TOTAL RETURN FOR NEXT FIVE YEARS
TO NAV OBSERVED
NAREIT (Public) NFI-ODCE (Private) Difference
Greater than: 15.00% 11 3.92% 10.23% 6.31%
10.00% to: 15.00% 7 9.26% 10.99% 1.73%
5.00% to: 10.00% 12 10.59% 8.95% -1.65%
0.00% to: 5.00% 14 9.56% 7.44% -2.31%
-5.00% to: 0.00% 8 11.00% 9.17% -1.83%
-10.00% to: -5.00% 11 14.46% 5.12% -9.34%
-35.00% to: -10.00% 12 14.70% 2.89% -11.80%
CURRENT: 3.4% as of 11/1/13
Sources: Greenstreet Advisors, NAREIT, NCREIF
4 © 2013bailard research CONCLUSIONS FOR PROSPECTIVE I NVESTORS I N PU B LIC REITs The conclusions from Bailard’s 2002 paper remain valid. In addition to the two standard investment policy recommendations from that paper—1) REIT portfolios should be diversified; and 2) investors should be prepared to stay the course and not be scared into selling during bear market sell-offs—the other two findings remain quite compelling: • If the markets continue to follow historical pat- terns, long-term investors (20-year horizons) in public REITs can reasonably expect to achieve re- turns roughly equivalent to those from similarly leveraged private real estate portfolios. Shorter term (five years), a portfolio of REITs is more likely to perform in line with small cap stocks than with real estate. • If you acquire public REITs when they are trad- ing more than 10% above their underlying esti- mated property net asset value, you are likely to underperform private real estate. But, if you time your purchases for periods when REITs are valued about equal to or less than their NAV, there is a good chance of outperforming private real estate. Thus, investors who wish to fill a real estate man- date should consider focusing on direct property in- vesting, not public REITs, if they want to capture the historic long-term return/risk characteristics of real estate as an asset class. © 2013 5
bailard research
R I SKS
All investments have risks, including the risk of loss. Pub-
licly-traded REITs have risks, including market risk and
the significant risks associated with their underlying
real estate investments. Private real estate risks include
illiquidity, changes in supply and demand, and inexact
valuation. There is no guarantee any investment strat-
egy will be successful.
D I SC LO SU R E
This white paper has been distributed for informational
purposes only and is not a recommendation of, or an
offer to sell or solicitation of an offer to buy, any par-
ticular security, strategy or investment product. This
white paper does not take into account the particular
investment objectives, financial situations, or needs of
individual clients. Charts and performance information
portrayed in this article are not indicative of the past
or future performance of any Bailard strategy, account
or product. Past performance is no indication of future
results. This white paper contains the current opinions
of the author and such opinions are subject to change
without notice. Information contained herein has been
obtained from sources believed to be reliable, but not
guaranteed. Bailard cannot provide investment advice
in any state or jurisdiction in which it is not registered
or exempt from registration.
Published November 2013
For more information, please
call 800.BAILARD (800.224.5273) or
visit www.bailard.com.
Bailard, Inc.
950 Tower Lane, Suite 1900
Foster City, California 94404
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