REIT - A Four-Letter Word that Makes Money

It was my second year in business school and that was the first time I heard the four letter word “REIT” or real estate investment trust. I learned that in the US there are over 150+ REITS publicly traded every day across core (e.g., apartment, office) and non-core (e.g., life science, data center) property types.

As a recent MBA grad in 2011, I was looking for an advisory role in institutional real estate and my search led me to Green Street. It was at GS where I learned the key approach to value a REIT is using Net Asset Value (NAV). Also, like real estate, a REIT unit (i.e., share price) tracks the underlying value of the levered portfolio it owns (see Prologis chart below). It doesn't sound groundbreaking right? Yet somehow, my private equity peers looked at a REIT as some distant cousin to private real estate investments.

In addition to the high quality portfolios owned by REITs, investors often get access to high quality management teams that are often (not always) disciplined with how they allocate the REITs’ precious capital. Relying on basic corporate finance principles, these management teams grow when the returns on investments are greater than the returns public investors expect (e.g., an investment delivers a 7% return when investors expect a 6% - that is a positive NPV deal or value creation!).

Despite the positive total return track record of US REITs over the last two decades (+10.7% annualized), investors often separate the teams investing in public real estate (REITs) from those investing in private real estate. This outcome may be a result of the following:

1. Private and public real estate performance is measured against different benchmarks. This leads to different incentives since portfolio manager bonuses may be assessed relative to a designated benchmark.
   

2. Assessing valuation of REITs requires a bit more education and securities analysis training. For example, is a REIT trading at a premium to NAV expensive? Not necessarily, but a REIT novice may conclude that as the case.
   

3. Private equity can offer unique investment opportunities not available in the public markets (e.g., cold storage in 2016). It is also a preferred structure by asset managers who aim to get rich from the promoted interest (e.g., Blackstone).
   

4. REITs entail more plain vanilla (core) strategies and desktop analysis, which to some is just boring. However, investing in private equity entails meetings with top-tier PE firms, property tours, term sheet negotiations, and all the deal-making fantasies every investment professional envisions in their finance classes.

Over the last six months, there have been some interesting investment opportunities in the REIT market. As an example, at one point Equity Residential (EQR) - a high quality blue chip REIT - was trading at a 5% cap rate. This occurred while private equity investors were looking at 4% cap rate deals in the same markets (e.g., NYC, SF, LA)! Smart investors who tracked the REIT market were likely able to take advantage of what appeared to be a “free-lunch.”

After having several conversations with investors and management teams in Latin America about this dislocation, I decided to host a webinar earlier this week with Martin Kollmorgen, the Founder and CIO of Serenity Alternatives. As Martin addressed the attributes of the REIT market and a few of his current sector favorites (e.g., apartment and data center), investors raised fundamental yet relevant questions for their own markets (e.g., “How do you trust the NAV?”, “Is this different from an IFRS NAV?). We could have spent an hour on several topics raised but we’ll likely address them on future webinars. So stay tuned.

In the meantime, keep in mind that a “REIT” is not just a four letter word. It’s an investment option that has delivered healthy relative returns for investors. As part of a broader real estate strategy I'd encourage investors to have both private and public real estate in their portfolios. Even if you don't invest in REITs, tracking the market will make you a better real estate investor.

Be Brava! and "Show me the Money!"

David De La Rosa