Institutional Investors Increasingly Using REITs in Portfolio Completion Strategies
By: David Sullivan, Nareit
Nareit's Investor Outreach team has met with some of the world's largest institutional investors over the past several years. Based on these conversations, Nareit expects more institutional investors will be considering REITs as part of portfolio completion strategies to gain access to a broad range of property types and geographic diversification, or to enhance their portfolios' ESG attributes.
This is an excerpt from NCPERS Fall 2023 issue of PERSist, originally published October 24, 2023.
REITs are widely used in the real estate strategies of nearly two-thirds of the largest and most sophisticated institutional real estate investors in the United States and globally. Approximately 64% of the top 25 largest defined benefit and sovereign plans in both North America and elsewhere use REITs to optimize their real estate investment portfolios. This trend is continuing to play out in 2023, as more institutional investors are using REITs as part of portfolio completion strategies to optimize, or complete, their real estate portfolios.
That's partly because REITs have long been recognized as playing a key role in helping institutional investors meet their real estate allocation objectives by taking advantage of relative valuation opportunities and improving their portfolios' overall risk/return profile. For example, research by Nareit and CEM Benchmarking shows that REIT returns have consistently outperformed private real estate by around 2% per year.
Institutional investors also increasingly understand that investing with REITs gives them access to modern economic sectors, offers geographic diversification, and enhances ESG attributes.
REITs Offer Access to Modern Economic Sectors
Many legacy institutional real estate portfolios are currently overweight in office and retail, and correspondingly underweight in modern economy sectors. REITs are becoming increasingly attractive to those investors looking to increase their exposure to newer, alternative economy sectors, including data centers, self-storage, health care, cell towers, and others. Case studies include:
- A U.S. healthcare system using an active REIT strategy to radically reconfigure its real estate allocation.
- The National Pension System of Korea allocating $1 billion to an active strategy benchmarked against a custom completion-oriented index.
- The City of Austin Employees' Retirement System (COAERS) using a passive completion REIT index to improve property sector diversification.
The chart above shows COAERS' REIT completion portfolio, which significantly increased its exposure to new and emerging sectors. COAERS reduced its exposure to office, industrial, apartments, and shopping centers from nearly 100% to around 60%, and added health care, data centers, self-storage, lodging, and others to gain strategic exposure to modern sectors.
REITs Offer Geographic Diversification
As of year-end 2022, there were 893 listed REITs with a combined equity market capitalization of approximately $1.9 trillion in more than 40 countries and regions around the world. Investors can easily diversify the geographic footprint of their real estate portfolio using REITs and listed real estate without the need to build out dedicated international teams or an on-the-ground presence.
REITs Enhance Environmental, Social, and Governance Attributes
Over the past decade, institutional investors have become increasingly aware of the sustainability and social responsibility profile of their investment portfolios. For these investors, REITs provide access to some of the best-in-class performers of environmental, social, and corporate responsibility. For example, Nareit's ESG Dashboard, which looks at the top 100 largest REITs by market capitalization, shows that in 2022, 87% publicly reported carbon emissions, up from 38% in 2017. Meanwhile, 99% publicly reported on their diversity, equity, and inclusion policies, up from 49% in 2018. In addition, a new article in The Journal of Portfolio Management shows that REITs have historically outperformed private real estate funds in terms of sustainability performance.
REITs provide sector diversification, geographic diversification, and can enhance a portfolio's ESG attributes. Institutional investors increasingly understand this and are using REITs as part of portfolio completion strategies because of these benefits.
About the Author: David Sullivan is the senior vice president, investment affairs at Nareit. He leads institutional pension plan, foundation, and endowment outreach for Nareit, which entails promoting and facilitating real estate investment through REITs to institutional investors and their consultants worldwide. This includes organizing roadshows, hosting meetings, and other marketing outreach targeted to institutional real estate investment officers around the world.
Prior to joining Nareit, Sullivan was an institutional real estate capital raising and marketing professional focused on the global real estate market, a role he held for 20 years at firms including Schroders, Barings, and CBRE Investment Management. During this time, he raised billions of dollars for public and private real estate equity and debt investment strategies from institutional investors across the U.S. and Canada.
Sullivan has an MBA from Columbia Business School, an MPhil in international relations from Cambridge University, and a BA in international relations from Boston University.