Reckoning or Revitalization - Video
Join us for a panel discussion exploring opportunities and headwinds that we can expect for real estate in 2021, and the effects of the pandemic on real estate.
Research has demonstrated that more than 90% of investment returns are driven by asset allocation—underscoring the importance of keeping a close eye on how a portfolio is allocated.1 In modern portfolio theory, each allocation should play a role in diversifying risk. Historically, in addition to providing diversification, REITs have also provided income and inflation protection. Notably, the average institutional portfolio allocation to real estate is 15%, although investors needs to consider their own investment goals when making allocation decisions.2
This is a fortuitous time for investors who are currently underexposed to real estate. According to Morningstar, since October 2016 real estate strategies have lost 7% of their assets to outflows.3 For those who have deviated from their strategic real estate allocations, now may be a good time to realign their portfolios. While equities have reached new highs, REIT prices still have room to recover.
REITs are attractively priced relative to fixed income based on their implied cap rate, a common measure of return for real estate.4 When looking at the implied cap rate spread over the 10-year Treasury, REITs are currently trading at near-term highs. The yields REITs offer are also attractive in an environment where interest rates are expected to remain low for an extended period.
Uncovering Opportunities in Real Estate
The global pandemic has impacted various property types differently — in some cases creating a headwind, while for others, serving as a catalyst for growth. In fact, the most recent drawdown in REITs was primarily driven by two sectors — office space and retail. These two property types account for a quarter of the benchmark yet contributed approximately 13% in drawdown. As a whole, the benchmark only declined 10%.5 Storage and industrial properties have been beneficiaries of pandemic-related demand trends and are up 8% and 9%, respectively, year to date. Active real estate managers can help investors gain access to key sectors at the right prices, turning dispersion into opportunity.
The pandemic profoundly disrupted real estate markets, spurring demand in some key areas – many of which are only accessible through REITs. These property types include industrial warehouses, data centers, and cell towers. In a shifting landscape, active managers have an important role to play in helping investors gain exposure to these sectors as appropriate, based on an individual’s risk/return profile.
In addition to leisure-based real estate sectors, we expect a dramatic recovery in the senior housing sector to begin in 2021. Most operators saw occupancy declines in excess of 10% as COVID-19 ravished the industry. We expect widespread vaccination to significantly reduce any health risk for would-be residents and reverse these recent occupancy declines. Moreover, the growing 75-and-older demographic in the United States is poised for dramatic growth in the coming decade, providing long-term secular demand support as an additional tailwind.
COVID-19 will be with us for a while longer and will likely cause some near-term volatility. However, real estate — and REITs in particular— are an attractive asset class in today’s environment. REITs offer inflation protection and an attractive yield in a low-interest-rate environment. Moreover, they stand to benefit from secular trends that are driving growth. For investors who are currently underexposed to real estate, this may be an excellent time to consider reallocating to REITs.
1 Determinants of Portfolio Allocation by Gary P Brinson, L. Randolph Hood, & Gilbert Beebower, December 2018.
2 Wilshire Analysis Surplus Optimization 1990-2017.
3 Morningstar as of November 30, 2020. Includes open end funds and EFTs; excludes fund of funds.
4 The implied cap rate measures net operating income over the equity market capitalization less outstanding debt.
5 Source: Factset and FTSE. Based on the FTSE EPRA NAREIT Developed Index as of October 30, 2020.
6 Source: Statista as of October 2020.
PGIM Real Estate is a unit of PGIM, a registered investment advisor and a Prudential Financial company.
Investing involves risks. Some investments have more risk than others. The investment return and principal value will fluctuate, and the investment, when sold, may be worth more or less than the original cost, and it is possible to lose money. Diversification does not assure a profit or protect against loss in declining markets. These risks may increase a fund’s share price volatility. Real estate poses risks related to overall and specific economic conditions, as well as risks related to investing in equity-related securities of real estate companies, principally real estate investment trusts, operating in the U.S., outside the U.S., and in emerging markets, and credit and interest rate fluctuations. Real estate investment trusts (REITs) may not be suitable for all investors. There is no guarantee a REIT will pay distributions given the inherent risks associated with the market. A REIT may fail to qualify as a REIT as defined in the Tax Code, which could affect operations and negatively. There is no guarantee a REIT's investment objectives will be achieved. Actively managed portfolios may carry additional risks, such as analyses performed cannot always predict outcomes, that the investment techniques applied do not have the expected results, and that external factors can change the course of investment performance. The fees associated with active management may be higher than those associated with passive strategies. The information contained is being provided as general investment education only and does not take into account the investment objectives or financial situation of any existing or prospective investors.
The information should not be construed as investment advice or a recommendation with respect to any security or investment strategy. Investors seeking information regarding their particular investment needs should contact their financial professional.
© 2021 Prudential Financial, Inc. and its related entities. PGIM Real Estate, PGIM and the PGIM logo are service marks of Prudential Financial, Inc. and its related entities, registered in many jurisdictions worldwide.
Prudential Financial, Inc. of the United States is not affiliated in any manner with Prudential plc, incorporated in the United Kingdom, or with Prudential Assurance Company, a subsidiary of M&G plc, incorporated in the United Kingdom.