September 5, 2019
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Nicolas Lyle, senior analyst, STANLIB Global Property Fund
The US REIT industry, represented by NAREIT, is a beacon for other countries looking to benefit from an investment regime that provides investors with attractive long-term sustainable returns coupled with diversification benefits.
The table below shows the extent of the industry’s growth over the last 47 years. Today, 170 listed equity REITs have a combined market capitalization of just under $1.2 trillion (FNER Index) and operate in over 15 property ‘sub-sectors’ (niche markets). Institutional ownership (and free float) is generally higher than in other jurisdictions, setting the standard for good governance in an industry previously dominated by tycoons.
As a result, the US REIT market is the most liquid and diversified (in terms of property subsectors) real estate market in the world. It is also the largest, reflecting the size of the US economy and the sophistication of its investment markets. An estimated 80 million Americans own REIT shares through retirement and investment funds, such as Simon Property Group (SPG), the world’s largest owner of shopping centres, Prologis (PLD), the largest owner of industrial and logistics facilities and Public Storage (PSA) the largest owner of self-storage units. These three and many other large US REITs have grown to also acquire and develop portfolios internationally.
Growth in US REITs since 1972
US REIT Performance
- US REITS vs US equities
Aided by growth in capital markets and a secular decline in interest rates, US REITs have delivered market-beating investment returns almost every year in the last 30 years, with a more pronounced outperformance since the end of the global financial crisis in early 2009.As shown in the chart above, US REITs have outperformed the S&P 500 and Russell 2000 indices by 30% and 44% respectively, despite the rise of tech giants such as Alphabet, Amazon, Apple, Microsoft and Facebook. The outperformance of bond and cash returns is many times greater.
- US REITS vs other global REITs
US REITs (95% of North America) have outperformed other developed market REITs over almost every time horizon including year to date, delivering a 10% annual compound rate of return in dollars over the last 25 years. The table below compares US, Asian, European and SA REIT performance over the long term and for the six months ending 30 June 2019
Source: NAREIT, SAREIT, Bloomberg. (Asia comprises Japan, Hong Kong, Singapore and Australia)
This consistent outperformance is largely a reflection of the structure of the US REIT market. Three key factors drive high performance:
- Specialisation (sub-sector focus)
Source: NAREIT, July 2019
The US REIT universe is significantly more diverse than other regions, with US REITs invested across 15 property subsectors (niches), including retail (Simon Property and Realty Income), residential (Equity Residential, Avalon Bay Communities), office (Boston Properties and Alexandria Real Estate) and industrial (Prologis and Duke Realty) to more alternative subsectors that have grown faster over the last two decades to become some of the largest REITs by market capitalisation.
Examples include: self-storage (Public Storage), healthcare (Welltower and Ventas), infrastructure (American Towers and SBA Communications) and data centres (Equinix and Digital Realty). These latter categories are well positioned to benefit from the needs of an ageing population as well as explosive growth in digital communications (5G and IoT) and data storage for cloud services.
- Relevance and liquidity
After five decades of growth, US REITs are larger in absolute terms and as a proportion of total US equity market capitalisation, on average, than REITs in other developed markets (only Australia is higher as a proportion). For example, there are 25 US REITs with a market capitalization of over $10 billion whereas in the next largest REIT markets there are far fewer (two in Japan and two in each of Germany and France).
US REITs’ higher level of liquidity and institutional ownership relative to other countries has generally encouraged higher quality management teams who are more accountable to institutional shareholders.
- Higher ROEs than peers
Over most time frames, US REITs have delivered higher return on equity (ROE) than other developed market REITs, and are forecast to continue doing so. This is the result of many factors, among others:
- Higher initial economic capitalization rates (initial yields adjusted for operating expenses, leasing costs and maintenance capex) providing a higher base for income returns
- Lower reliance, on average, on projects (aka developments) (they have a higher proportion of portfolios that are income generating) to generate income returns
- Larger portfolio sizes and values on average, allowing for greater economies of scale in operating costs and therefore higher earnings margins
- Lower dividend payout ratios (65-75% vs 90-100% for other jurisdictions) allowing tax efficient compounding of investors’ equity returns
- Higher institutional ownership rates, instilling greater discipline on capital allocation (mainly property disposals) and maintaining high rates of return through the cycle
- As a result of these factors, US REITs enjoy, on average, lower costs of capital, (share prices trade at premia to net asset values relative to other jurisdictions) providing greater opportunities for growth.
A diversified portfolio designed to deliver sustainable income growth for its investors would benefit from a long-term allocation of 10-20% to global REITs.
We believe that global REITs are a more attractive proposition for the long term than SA REITs and for now, we continue to prefer US REITs over those of other developed markets.