Anyone checking out property values on Zillow or similar websites, or buying or selling a home, has probably noticed the hot market for residential real estate in many parts of the country this year. But the recent track record of real estate investment trusts, or REITs, presents a less rosy, more scattered picture.

After delivering a total return of 28.66% last year, the FTSE Nareit All Equity REITs Index fell 12.3% for 2020 through the third quarter. Most real estate sectors in 2019 were up by double digits; so far this year, most of them are down by as much, or more.

The widely disparate impact that the Covid-19 pandemic has had on various corners of real estate is reflected in year-to-date returns through September 30, which ranged from a negative 54% for regional malls to a positive 26% return for data center REITs. Other hard-hit sectors this year include lodging/resorts (which fell 49%), retail (which fell 40%) and offices (which fell 30%). Among the most resilient corners of the REIT market were infrastructure (up 14%), industrial (up 9%) and self-storage (up 6%).

“The pandemic accelerated trends, such as competition from online shopping, that were already in place before this year,” says Brendan Lee, co-manager, with David Copp, of the TIAA-CREF Real Estate Securities Fund. “But there’s always a bull market in real estate somewhere. Our job is to look for it.”

Copp and Lee have been doing that for nearly 25 years, well before they began managing the fund in 2006. Their paths first crossed in the late 1990s, when Copp was an analyst writing research reports on REITs for an investment firm, and Lee used his work to help guide investment decisions at a real estate hedge fund.

The collaboration has worked well thus far. Over the last three, five and 10 years, the portfolio of about 50 to 70 names has performed better than the vast majority of its Morningstar peers, with less risk. It has done well in both boom and bust cycles. In 2019 it was up 31%, beating the index by over 2 percentage points. In 2020, it fell about half as much as the index through the third quarter. The $2.7 billion fund’s reasonable expense ratio of 0.62% for “Advisor” class shares has also taken a below-average bite out of returns.

As they have through most of their tenure, the managers work from their respective homes in Southern California about an hour away from each other, but they are in constant contact through phone, e-mail and texts. “The work- from-home trend is something that has been an investment thesis recently,” says Copp. “But we’ve been doing it for a long time.”

One thing that has changed is travel restrictions, which make it necessary for them to do more virtual property tours rather than physical visits. “Physical inspections are important, but we can still make decisions without them,” he says.

Playing More Defense
Like other equity REITs, those in the fund’s portfolio own and operate income-producing real estate, and shareholders receive that income in the form of dividends. To qualify as REITs, companies must pay out at least 90% of their taxable income, which is why they typically yield more than most stocks.

“The classic reasons for investing in equity REITs still apply now,” says Copp. “They allow investors to have a stake in large commercial properties and assets that they can’t invest in directly. They’re a great diversifier and inflation hedge. And they are more liquid than physical real estate.”

Lee adds that valuation metrics in this area are attractive when you compare them with the rest of the stock market, and he remains optimistic about the future. “Things certainly look negative now in some areas of the real estate market. But we think that in the next 12 to 24 months demand will bounce back.”

Copp and Lee say the portfolio is populated by companies boasting experienced management teams they’re familiar with, as well as above-average earnings and cash flow. The companies also have acceptable levels of debt. After the managers buy a REIT name, they typically wait two to three years for their investment thesis to play out.

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