Real Estate is much more than bricks and mortar. To be a successful investor in the real estate industry, it is important to not only analyze and understand the industry-specific economic indicators, but also to understand the second and third order effects of their impacts.
The real estate industry has performed well over the past few years and REITs have been a large component of those returns. REIT sectors, such as multi-family and office, have performed particularly well, and their subsequent popularity among investors has led to share prices trading at premiums to Net Asset Values. Not an unusual progression, but with interest rates and cap rates near historic lows, it’s worth considering how much compression of either metric is available, if any. Additionally, pressures from increasing supply will inevitably impact the revenues and exit valuations for the assets managed under these REIT structures.
Trends outside of customary performance metrics could also soon come into play. According to Garrett Gish, Director of the Global Business Division at FCA Corp, social and generational shifts could have significant impacts on sectors like multifamily. Millennials, for example, now make up the largest share of homebuyers, according to the National Association of Realtors, despite a historical track-record of poor saving habits and frequent relocations. Recent surveys published by CNBC indicate well over 70% of millennials are willing to cut back on extracurriculars to make a home purchase a reality, and 52% feel financially ready to make the purchase.
The single-family housing supply remains well below existing demand, as inventory has dropped 23.3% over the last five years and starter home prices have increased 57.3% in the same period, which creates a substantial opportunity for developers and sector-specific REITs focused on single-family. As such, tangential industries like timber stand to benefit. Timber represents more than 30% of the material cost of single-family home construction. Companies that have vertically integrated the timber, land rights and manufacturing components of the supply chain not only have higher correlations to the residential housing sector, but also tend to outperform pure-play timberland owners. According to Robert Scharar, Commonwealth Funds President and Head Portfolio Manager for the Commonwealth International Series Trust, exposure to these kinds of real estate assets can lower risk profiles and increase overall portfolio returns.
The immediate impact of sector-specific economic data is important and drives the high-level investment decision-making process, but a long-term outlook and consideration of real estate related industries beyond the bricks and mortar can prove to be just as valuable, if not more so. To learn more about Commonwealth’s approach and its Real Estate Securities Fund, visit commonwealthfunds.com or call 888.345.1898.