It has been an eight-year run for equity real estate investment trusts, returning almost 450% to investors, or roughly 20% per year. The broader equity market has also been on a tear, returning roughly 350% during the same period. Relatively easy monetary policy persists, credit spreads remain tight and the U.S. economic expansion is almost 100 months old — the third longest in history.
Advisors now find themselves at a crossroads. On one hand, one could argue that not only are REIT valuations stretched, but the fundamental cycle for commercial real estate has generally peaked. For example:
- Supply has trended higher in the multifamily sector, eroding rental rate growth, while a shift toward a service-based economy has disadvantaged self-storage demand and depressed market rents.
- Traditionally stalwart property types, such as regional malls and shopping centers, have succumbed to e-commerce pressures, softening productivity and sales trends.
- Even trophy office assets located in major cities are facing slower leasing, as tenants rationalize space needs to enhance efficiency and promote collaboration among employees.
Aggravating these real estate trends is an uncertain environment for the equity market. Geopolitical anxiety stemming from North Korea's nuclear ambitions, Russian election-tampering allegations, central bank tightening and uncertainty regarding U.S. tax reform, have left advisors questioning the sustainability of the U.S. economy and the future direction of equity returns.
Yet the old Yogi Berra aphorism — "It ain't over till it's over" — could apply to present-day markets.
Commercial real estate evolved from an alternative asset allocation into a mainstream investment classification when S&P Dow Jones Indices created a new real estate sector in 2016. This promoted REITs to a sector all their own, providing enhanced liquidity and exposure.
