Brad Case

There’s little difference between the income earned by the largest, most sophisticated investors in private equity real estate and the income earned by the smallest individual investors in listed equity REITs. 

Listed equity REITs have generally outperformed small-cap value stocks, posting slightly higher returns but substantially lower volatility and substantially better diversification benefits.

Cambridge Associates reports that private equity real estate funds have underperformed listed equity REITs by 3.91 percentage points per year over the past 25 years.

Value-oriented and momentum-oriented investors look to take advantage of different opportunities: value investors look for stocks selling well below normal, while momentum investors look for stocks that have done well recently.  Both opportunities can be found today among sectors of the REIT market.

Appraisal-based valuations in private real estate markets are being systematically reported at levels that exceed those of reported transactions—in which case there may be more valuation risk in private equity real estate markets than many institutional investors realize.

While valuations are somewhat different across different segments of the REIT industry, there is a “wealth of undervaluation” in REITs today—and investors certainly should be paying closer attention.

Over the first six months of 2017 the broad U.S. stock market had outperformed the REIT market, with the Russell 3000 Index showing total returns of 8.93% compared to just 5.43% for the FTSE NAREIT All REIT Index.  Dig just a little deeper, though, and this turns out not to be a “stocks vs REITs” story at all.

I think it’s very difficult to make any thoughtful (let alone empirically based) case for predicting that the current real estate market cycle is nearing its end.  The evidence simply isn’t there.

Will the gap be closed through underperformance in what may be an overvalued private real estate market, overperformance in what seems very clearly to be an undervalued listed REIT market, or a little of both?

The headline for the Mortgage REIT industry is a big one: the dividends paid by exchange-traded Mortgage REITs yield 10.54%, on average, as of the beginning of February 2017. 

Here’s the myth: an increase in interest rates is bad for real estate investors.  Here’s the empirical fact: the historical evidence shows that real estate investors—at least those who invest through exchange-traded REITs—have usually done better during rising-rate environments than when interest rates were declining.

There’s a persistent, predictable relationship between the liquid and illiquid real estate markets: private-side real estate valuations respond more slowly to changes in market conditions than do public-side valuations, so the values in private, illiquid markets typically lag public market values by two to five quarters on average, depending on whether participants in private markets are evaluating market conditions by looking at completed transactions or at property appraisals.  Correcting for that lag can give you a pretty good sense of whether a public/private arbitrage opportunity has arisen.