Since the end of August, more capital has flowed into real estate—and that trend will continue, says Chip McKinley, senior vice-president and portfolio manager with Cohen & Steers in New York.
Why? As of August 31, real estate was reclassified as its own Global Industry Classification Standard (GICS) sector, and it’s anticipated that investment will keep flowing into the space. Among other real estate funds, McKinley manages the Renaissance Global Real Estate Fund.
“It’s hard to specifically quantify the amount of assets that shifted into real estate securities directly and [through] actively managed funds and ETFs,” he says. But, “we have estimated that the total capital flow ultimately will be in the range of somewhere around $20 billion to $50 billion.”
However, this investment influx will be gradual because “there [are] some views that real estate is fully valued, and some people simply won’t get around to [investing] for a while. There [are] different opinions around the future outlook for real estate.”
But one thing’s for sure, says McKinley: “Across every generalist strategy—whether it’s large, small or mid-cap strategies, or growth or value—investors […] are structurally underweight real estate.”
The reason for this, he adds, is “likely because the language and valuation metrics that are most important for real estate are unique to [the sector]. In other words, they’re not [used for] any other sector, so you have to learn a new discipline when valuing real estate and how to think about it. That’s been a structural barrier to a lot of managers taking the time to learn and make an allocation to it, and that’s why [investors] have been underweight.”
What will clients want?
Going forward, says McKinley, it will be harder to overlook investing in the space. “It’s [now] immediately clear to any investor or client that [they’re] underweight or [have] zero weight real estate. So I think it’s going to force [people] to look at [the sector] more. Whether they decide to invest more is unknown but I think, ultimately, there will be a shift gradually toward [higher] market weight.”
For example, he says, “If you just have [fund] managers shifting toward a market neutral position [in real estate], that’s an inflow of somewhere between $20 billion and $60 billion.”
McKinley says reclassifying real estate as its own GICS sector was a good move. “It means real estate has been separated from financials, [and] that means whenever you have a risk-off market where everyone is shorting banks and insurance companies, they don’t have to short real estate at the same time. That’s exactly what has been happening for the last 20 years.”
As a result, real estate won’t be as volatile. Plus, says McKinley, “Correlations should diminish, making real estate that much more appealing [for] a diversified portfolio.”
Where you can invest
If you’re looking at real estate for the first time, look at the largest, most liquid names that represent the entire REIT space, suggests McKinley. “As new institutional, active fund investors evaluate real estate, or at least as they devote new attention to it, it seems to me the first step for them will be to look at [these names].”
A few examples are:
- Simon Property Group, a large mall company;
- Equity Residential, a large apartment REIT; and
- Prologis, a large industrial property REIT.
McKinley predicts newer real estate investors will pick names like these, mainly because they’re the most liquid. But that may not be the best strategy, he adds, given “there’s […] a misunderstanding that real estate is a homogeneous, monolithic group of stocks or companies with very high correlation.”
The common assumption, he notes, is that if you invest in the five largest American REITs, “you’ve covered the entire real estate sector. [But] that’s completely wrong; [those REITs] show enormous dispersion of returns from year to year.”
So, you need to help clients understand that real estate investments are all unique. You should look at “property types, business strategies, geographic exposures and tenant exposures and risks to understand where the risks really are and where the opportunities really are [in the space].”