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AEW’s Szymanski Sees More Momentum for REITs

REITs have outperformed the broader market so far in 2021, and one large real estate investment advisor explains why she sees even more upside potential.

After facing tough market challenges last year, REITs appear to be on course for a bull run as 2021 continues to unfold.

Total returns on the FTSE Nareit All Equity REIT Index surged from the -5.12 percent recorded in 2020 to 15.04 percent year-to-date as of April 22. So, what’s ahead for REIT performance and strategy in the coming months? “The easy money where people rotated into the value trade where there were heavily discounted stocks has been made, and now it’s about earnings growth recovery,” says Gina Szymanski, director and portfolio manager at AEW Capital Management, one of the world's largest real estate investment advisors.

According to its most recent REIT Strategy Quarterly Webcast, AEW is predicting  average cash flow yield of 4.7 percent and dividend yield of 3.6 percent this year. Earnings growth, excluding hotels, is projected to be about 3 percent in 2021 and then grow to 9 percent in 2022. The strongest growth is anticipated in net lease, niche residential, self-storage and hotel REITs, while healthcare, apartment, office and retail are forecast to have weaker growth in 2021 and then rebound in 2022.

AEW and its affiliates manage approximately $85 billion in property and securities globally on behalf of more than 400 clients, including approximately $5 billion invested in REITs. WMRE recently spoke with Szymanski to hear more about AEW’s investment strategy and outlook on what’s ahead for the REIT sector in 2021.

This transcript has been edited for style, length and clarity.

WMRE: There already has been a rally in the REIT sector this year. Overall, what’s your view on where the REIT sector is at and where it’s headed in 2021?

Gina-Szymanski.jpgGina Szymanski: REITs have outperformed the broader market year-to-date. That wasn’t entirely unexpected given the underperformance of the sector in 2020. So, we came into the year at what we thought was attractive valuation relative to other asset classes.

A lot of property types have this headline around them that real estate was significantly impacted in a negative way by the pandemic, which isn’t totally true, but there are a lot of common REIT types that everyone thinks about when they talk about real estate, like office, hotels and malls that did suffer through COVID. So, there was reason for the sector to lag.

We have made some catch up, and when we look forward, it really comes down to our outlook for what we’ve think is going to be the earnings recovery and the valuation recovery for the companies that we follow.

WMRE: Can you expand on that outlook?

Gina Szymanski: Our benchmark cash flow per share was down about 8 percent in 2020. We expect that to rebound to about 10 percent this year and accelerate to 20 percent next year. A lot of that is hotels. As we know, hotels were essentially shut down across the industry. Many REITs barely had 10 percent of properties open. That sector was down over 100 percent and is going to rebound over 100 percent. If you exclude that, you get low to mid-single digit growth this year for cash flow and then 9 percent next year. So, with or without hotels, we expect acceleration next year. We think investors can still look to REITs as an investment opportunity, because we do have accelerating growth.

A lot of the concern over the real estate sector generally has to do with inflation. As people get concerned with inflation because of the stimulus and accelerating GDP growth, everyone worries that REITs are inversely correlated. So, as interest rates go up, REITs go down. What I always tell people is that it depends on the growth.

The biggest offset to inflation is growth, and our sector has it. Some sectors that were impacted by COVID are going to reopen and have accelerated cash flow as the pandemic eases. We also have a number of property types that had really strong fundamentals through COVID.

WMRE: People still talk about REITs being undervalued relative to NAV. Do you share that view, and do you expect some upside in price growth as well?

Gina Szymanski: There are so many ways to look at valuation. The way that we look at it is on a total return basis. That combines discounts to private market values with our expected growth in the underlying private market value, and then you layer in dividend yield. For our space, dividend yield is just under 4 percent. So, that is imbedded.

We expect net asset value growth to be more or less in line with earnings growth for high single digit NAV growth. The valuations relative to private markets aren’t screamingly cheap right now, but a lot of that is because the cash flows have been written down, meaning that some of the property types that are experiencing lower cash flows because of the pandemic effectively writes down net asset value. We think the upside in REITs comes from the dividend yield, as well as the net asset value growth, but valuations should hold and follow the underlying value of the private real estate in these portfolios.

WMRE: What are some of the top REIT concentrations that you are in right now?

Gina Szymanski: We are very positive on our position in industrial. Industrial has been overweight for us for a number of years. Right now industrial properties have vacancy rates at historic lows, and even though there is new supply being delivered, it’s not causing net absorption to be negative. There is still sufficient demand to offset supply, and landlords continue to have a lot of pricing power. So, rent growth is still very strong in relation to other property types. Institutional demand for the sector is almost as strong as I have ever seen it. We have clients coming to us specifically to invest just in industrial—and some other property types where they are underweight from a private equity standpoint.

What that means in our opinion is that the valuation multiples, or the cap rates applied to industrial will continue to move lower.

We also are overweight in affordable residential, and I would highlight single-family rental specifically. Single-family rental was an industry born out of the Great Financial Crisis. Now it has legitimately become an institutional asset class.

While there are many millennials who want to buy homes, which you can see in the strength of the housing market right, you also see them not wanting to come up with the down payment, or they want to stay mobile. But to the extent they have kids, they don’t want to live in apartments anymore. So, there is very strong demand for single-family rental homes. Vacancy rates are at historic lows with pricing power that has never been better.

WMRE: We hear more about specialty niches within the REIT sector. Do you stick to the core food groups, or do you have interest in some of those specialties?

Gina Szymanski: Single-family rental is one of those niche sectors. So, we don’t differentiate. Our benchmark is comprised of both core sectors, as well as niche sectors. The niche sectors have grown in importance over the last decade by leaps and bounds. We look at the opportunities in front of us whether they are considered traditional or non-traditional. In addition to single-family, we own positions in sectors such as manufactured housing, self-storage and seniors housing.

WMRE: Are there any sectors where you are increasing or decreasing investment because of the pandemic?

Gina Szymanski: Before the pandemic we were underweight in office on the margin. But over the last several months we have added some office names. We picked up some exposure to the office sector because we thought the sentiment around work-from-home being the new norm for every company is a little overdone. We are still underweight, and we do still think there are headwinds from work-from-home on demand, but we also think employment is going to increase as we exit the pandemic. Employment growth is the main driver for office demand. So, there is reason to believe that office is an asset class that will still be needed.

WMRE: Looking ahead to REIT performance, are there any key indicators that you are keeping a close eye on these days?

Gina Szymanski: I think the key going forward over the next year and a half is really the pace of recovery that has been imbedded into earnings expectations. We look at what the sell side has modelled. We think about what we believe. We look at the pace of vaccine roll-out and what that’s going to mean for businesses reopening. We keep a close eye on regulations, especially in some of the major states like New York and California.

What’s going to matter the most is whether these companies are going to be able to produce fundamentals that match people’s expectations of what the reopening is going to look like. Those sectors that produce on the ground fundamentals that are better than people expect are going to outperform. And those that have a challenge with meeting expectations are going to underperform.

WMRE: AEW represents more than 400 clients globally. How do you keep connected with investors these days?

Gina Szymanski: We had rolled out work-at-home capabilities prior to COVID. So, as a firm we didn’t skip up a beat when COVID started, and we have been able to maintain contact with our investors throughout the pandemic. We are mostly institutional in terms of our clients, and we talk to our clients at least quarterly with performance update calls and an annual conference that is usually held in May. That annual conference was virtual last year, and we’re going to do that again this year.

We also have research events. The head of our North America research, Mike Acton, typically goes from city to city in different regions to host research lunches with clients. That was impossible in person during COVID, but we have done that virtually on Zoom. In lieu of being there in person and the expenses of travel, we also donate an equivalent amount to local charities in that region. So, we are trying to make the best of the pandemic, while still maintaining really strong relationships.

WMRE: What are you hearing from clients regarding their appetite for REITs?

Gina Szymanski: Increasing demand. Our clients are coming to us saying that they think equities are expensive, bonds are expensive, and they find real estate to be the only asset class that makes sense to them right now. We have heard that over and over in the last several months. Because equities have outperformed REITs in the broader equity universe, people who were under allocated are now even more under-allocated. So, even for those who didn’t think there was an opportunity in REITs, they still have to rebalance portfolios. From an opportunistic standpoint, they also think REITs make sense relative to other investment alternatives.

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