09/27/2010 | By Bill Hauser
Today, REITs represent approximately two-thirds of the value of listed property shares globally. The pace of securitization – by way of IPOs and adoption of the REIT structure in new countries – obviously has moderated. However, the significance of the REIT structure has not.
The strength and importance of the REIT format has been clearly demonstrated in the most recent market cycle. The ability of quality entities to raise capital, under the most dire of market conditions, proved a watershed event in 2009 that will likely set the stage for the period ahead.
Some would suggest that at approximately 5 percent of the global commercial property base, real estate securities play a narrow role. I firmly disagree – this figure clearly understates their importance in the market. The degree to which a new wave of securitization would bring more assets into the public market is less material than the fact that going forward, REITs will hold access to attractively priced capital, and thereby the percentage of assets held in the public market may gradually increase.
The vital role of the REIT structure has been validated.
The gates between public and private markets will continue to open in both directions. Both markets serve a role. However, for both investors and real estate entities, the virtues of the REIT structure have again been proven. Without REITs and the capital raises completed in 2009, the property industry could have likely absorbed deeper blows. Securitization has also brought greater transparency to supply and demand conditions. This stands in contrast to opacity of market information in the 1980s. In my personal view, a large part of the ongoing, and quicker than anticipated, healing can be ascribed to securitization.
At present, the market is placing a premium on yield-oriented assets – risk aversion appears to dominate investor psyche. The pace of fund flows – out of U.S. equity mutual funds and into fixed-income strategies – remains firmly in place. U.S. equity funds have experienced outflows in excess of $200 billion since early 2008. Compare that against bond funds, which received $375 billion in 2009 and another $180 billion for the first seven months of 2010.
This is by no means the first time that concerns about economic growth and the health of the financial system have dominated investor sentiment. In many prior instances, be it the deflationary environment of the 1930s or inflationary environment of the 1970s, investors were often frozen in place.
Following these and other market downturns, dividends proved to be of great importance to bring investors back into the market. Today, I believe similar conditions exist. With tangible assets, sustainable cash flows and attractive dividend yields, REITs will likely garner increased investor interest.
During the days of heady capital appreciation, investor appetite for dividend yield appeared thin. Going forward, as dividends will likely comprise a larger portion of total returns, dividends will take on added focus.
Here again, REITs stand to benefit.
For years we've discussed the power of demographics. I think of demographics as a large, slow-moving ocean vessel that leaves a powerful wake. We are all aware of the importance of yield – and the virtues of REITs for the current swell of an aging population. Other demographic considerations, from the maturation of Generation X to growth and urbanization of countries like China, will also be of importance.
In our view, significant investment opportunities remain in many developed property markets. In fact, we believe that the United States will remain the deepest and most liquid market over the next decade. (Yet, on a percentage basis, new markets will likely take on added importance.) Investment expectations of the new demographic are changing, and REITs will serve an increasingly valuable role.
Overall, I believe that the recent tests of the REIT structure have further solidified their attraction and long-term importance – both in the U.S. and globally.
As vice president and portfolio advisor with Prudential Real Estate Investors, Bill serves as liaison for PREI®'s global real estate securities portfolios. Bill holds over 20 years of real estate and securities investment experience. Prudential Real Estate Investors has been Investing in real estate on behalf of institutional clients since 1970, with gross assets under management of USD $43.1 billion and net asset value of $23.4 billion, as of June 30, 2010.