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The Millionacres Hour: Interview With Abby McCarthy, Nareit’s Senior Vice President of Investment Affairs

Millionacres editor Deidre Woollard and Senior Analyst Matt Frankel interview Abby McCarthy of Nareit on why REITs are a great investment, what the future holds for publicly traded REITs, and which sectors are seeing the most growth.

Transcript

Deidre Woollard: It is two o'clock Eastern Time. I'm here with Matt Frankel, our internal REITs analyst and brilliant person on all things REITs. We also have Abby McCarthy who is Nareit Senior Vice President of investment affairs. Really excited to have a conversation today about REITs, and I think it's a fun day to have it, because at least some of the REITs that I'm watching are having a pretty great day on the market.

Matt Frankel: My portfolio is definitely getting killed, but the REITs are doing all right.

Deidre Woollard: All right.

Abby McCarthy: Thank you for having me on. I'm looking forward to our conversation.

Deidre Woollard: Absolutely, our pleasure. 2020, maybe not so great for REITs. Can you share some of the reasons behind that?

Abby McCarthy: Sure. REITs actually did end last year in the negative territory down about five percent. A lot of that obviously was due to the effects of the pandemic and the various business dislocations and shutdowns that we saw definitely impacted tenants, which then impacted their landlords, of which the REITs are. We did see in particular, in certain sectors, there was quite a bit of decline last year in total REITs performance. Really I think what it keyed off of was the real estate's overall exposure to social distancing. In sectors where social distancing really played a key part of whether the business could be open or not, and I'm thinking of retail, senior housing or healthcare, and office we did see some decline in REIT performance. Now, it was interesting though that there was the other side of the real estate sector, that side which really is the backbone, I would say, of the digital infrastructure of our country. I'm talking about datacenters, industrial logistics facilities, cellular towers that actually performed quite well. As all of us moved to Zoom meetings and to making most of our purchases online last year, those sectors actually saw great performance. Overall the industry was down. But again, we saw some pluses and minuses based on that social distancing in the impact of COVID-19 on the different real estate types.

Matt Frankel: So a lot of REITs have done really well since the economy started to reopen. I think since the initial news that the Pfizer vaccine was released in November, a lot of the sectors you mentioned like retail and things like that have pretty much gone straight up. Do you think we've seen the bulk of that or do you think there's a lot more potential as the economy keeps getting back to normal.

Abby McCarthy: It's obviously difficult to forecast the future when you're talking about stock performance. I think what we see is still quite a bit of upside. For example, in the lodging and resort space, we do know that there has been a lot of improvement priced in to the hotel REITs returns recently and they've seen great performance. But we also know that there's still some constraints in that property sector. We do anticipate leisure travel to pick up quite robustly in the next couple of months as people have delayed or canceled weddings or family gatherings in this past year, and as more of the vaccine rollout continues to happen, we do anticipate leisure travel to increase quite a bit. Business travel, I think will still stay somewhat constrained. We've seen some recent surveys that have suggested that only somewhere around 65 percent of folks believe that they will be traveling for business in the second half of this year. I think that really allows for more upside potential in the lodging space going forward as we see that leisure recovery and then eventually a business travel recovery as well. Other sectors that I think are really poised to do well are any of the sectors that have to do with housing. I'm talking about apartment rentals, single-family rentals, and manufactured homes. We're really seeing a tremendous amount of demand across the housing space. Most of the REITs in the apartment sector own very high-quality apartments in major metropolitan areas, which I think some people felt at the beginning would see as people fled to less expensive areas that there would be some stress there. But really, I think what we've seen is that those occupancies has stayed consistent, that the tenants in a lot of those properties tend to be those who can also manage working from home. Then going forward, I really think that we're seeing in the single-family rental market a tremendous amount of demand, as there is a significant portion of Americans who are not ready or in a position to buy a home, but would like the space and the extra amenities that being in a single-family rental provides you. We see strength in those sectors. Also, what's a bit surprising right now is that retail has quite a bit of bounce back strength. We are seeing that as people are becoming vaccinated, they're actually returning to malls and especially regional shopping centers where many of the businesses have already reopened or have been able to reopen with some sort of COVID restrictions in place that actually make it viable for people to shop, eat and return to those centers. Those are the three main sectors that we really are seeing strength right now.

Deidre Woollard: That's fantastic. I love that you mentioned manufactured because that's an area that I think is starting to emerge a bit. Is that something that you've been keeping an eye on as well?

Abby McCarthy: Yes, I think that manufactured home space is a little bit unique. It's actually consistently had strong return earnings over time. It's an interesting niche market of the housing sector, that again, has shown great resilience and strength during this time. I should also add, if I'm going to be talking about areas of the REITs space that are strong, I do have to come back to those sectors that really are providing such the backbone of our digital infrastructure right now. Again, they had a great year last year. They're not seeing as strong a performance this year, but still strong performance in our industrial logistics space, our datacenters, and our cellular towers, which I think will just continue to improve over the coming year.

Matt Frankel: A lot of our investors are new. We've added a ton of members over the past year. Thank you to those who are listening. For those who are new and may not be that familiar with the REITs concept, what would you say to new investors on why they should think about adding REITs into their portfolio instead of maybe just focusing on the headline grabbing growth stocks we've seen over the past year.

Abby McCarthy: Sure. Nareit actually has been studying the investment merits and benefits of REITs obviously since our existence in 1960 and through multiple research studies and multiple research partners, we consistently find that REITs really provide great diversification benefits to portfolios. They have very strong long-term performance with reliable income components through their dividend yields and capital gains. In addition, they have low correlations with other equities, which I think comes as a surprise to some people, which really then provides a good diversification balance in the portfolio. I think what also makes REITs interesting for new investors is that if you're going to have an exposure to real estate, there really is no simpler or more inexpensive liquid way to access the commercial real estate asset class than through REITs. They obviously can be bought and sold through securities or mutual funds or ETFs on a daily basis. They're priced daily, which I think makes it easier to get into and out of, and also easier to understand. But I do think all your new investors should definitely take a close look the way REITs are structured. They are required to pay out 90 percent most payout almost a 100 percent of their income in the form of dividends. So there is a great income component. I think what we find is that REITs really play a role in any age portfolio. For people who are saving for retirement, you get that nice compounded return that added benefit from income plus capital gains over a long period of time in a tax-deferred vehicle. Then for our investors who are in retirement or getting close to retirement, REITs really offer really nice income stream through a robust dividend yield. The dividend yield on REITs is more than double that of the S&P 500, making it a nice income tool for any diversified portfolio.

Matt Frankel: Excellent. REITs are obviously a great fit for retirement accounts. They don't pay taxes at the corporate level so if you put them into retirement account, you can really just avoid taxes on all sides. Do they make good investments for standard investment accounts as well as someone's not looking to invest in their IRA or something like that?

Abby McCarthy: I think REITs really play a role. It depends on your risk tolerance and your long-term investment goals. But Matt, as I was mentioning before, what we've really found is that an investment anywhere between five and 15 percent of a portfolio in REITs, really provides that nice risk-adjusted return, that nice diversification benefit where you're adding return without increasing the risk of your overall portfolio. Then also really protecting it with those little correlations with other equities so that you can weather the up markets and down markets. That's true for any portfolio, whether you're saving for retirement or if this is in your general investment account.

Deidre Woollard: One of the things I want to ask you about was mergers and acquisitions activity in REITs. It seems like last year for obvious reasons, deal flow was not really there. But this year already we've seen a lot of activity. I know Kimco and Weingarten announced this week. What are you seeing and what do you think we're going to see more of this year?

Abby McCarthy: Well, I think the fact that we are seeing some of these big name mergers and acquisitions in the space is a really good sign. M&A activity is always a good sign of a robust and healthy industry. So I think that alone is a plus for the REIT industry right now. M&A activity also, I think can lead to the benefit of shareholders. Because obviously, if you have a situation where you have complementary retail portfolios across the country, you can really reduce costs and that long term is to the benefit of the shareholder. I think that given that we've seen a few mergers and acquisitions be announced this year so far, I wouldn't be surprised if we see a few more by year end. But again, to us, I think it really just indicates some economic strength. I think that there's also some confidence in the management teams of some of these REITs, that now is a time where they can get into the market and increase the deal flow.

Matt Frankel: You said REITs are really nice way to add diversification to our portfolio, so is it just a different kind of asset class, are they less volatile than maybe some of the stocks our investors are looking at? Can you expand on the diversification principle and how real estate performs over time?

Abby McCarthy: Yes. Real estate, if you're looking at the entire investment market, which commercial real estate makes up about 14 percent. When I'm saying the entire investment market, I'm talking about equities, bonds, cash, and commercial real estate. Those are really seen as the fundamental asset classes of the investment market, and obviously to invest wisely, you have to own the investment market. What makes commercial real estate standalone as its own fundamental asset class is that it really has its own real estate cycle, which is different from the business cycle, which makes then the overall performance and returns the industry different than that of equities or bonds. Now, REITs actually are a wonderful representation and an easy and low-cost way of accessing the commercial real estate asset class for investors. As I mentioned before, I think the studies that we have shown shows that allocation to be somewhere between five and 15 percent, which definitely matches up with the overall exposure of 14 percent of the commercial real estate asset class has in the overall investment market. Obviously, REITs are that easy liquid way of accessing that. Commercial real estate has a role in every portfolio and REITs are the easy way of accessing virtual real estate asset class through that.

Deidre Woollard: Abby, I want to ask a little bit, or if you could share with listeners what exactly Nareit does and why it's so important? Matt and I use it as a resource all the time but I was wondering if you could share more of that with our listeners.

Abby McCarthy: It's good to know that you all use it as resource, because we have a lot of information that we put out on our website and I'll get to that in a minute. But Nareit is actually the industry association that represents REITs and all of those businesses that service the REIT industry. My particular team that I am on focuses on research and investor outreach. Our research team, we have a team of economist that work for Nareit, that create research. Then we also partner with organizations such as Morningstar or Willsher Investment Management to create research projects as we look into the various things that we've talked about on this call so far in terms of the role that REITs play in a portfolio, diversification benefits. Then additionally, we also work with academics and encourage and support academic research that's happening in the REIT industry. On the investor outreach team, we take that research and we take all of that information, and we share it with the various pieces of the retirement market, whether it be pension funds, endowments, foundations, defined contribution plans, or financial advisors or individual investors. We have this wealth of information on our website that is to help investors understand REITs, and then actually understand the different ways that they can invest in REITs. One thing that we also do is we do a lot of market research to understand how those different sets of investors are utilizing REITs in their portfolios. We actually just recently did a great piece of research with Chatham Partners on the utilization of REITs among financial advisors. Where we found that 83 percent of financial advisors that we talked to for the purposes of the research study are utilizing REITs and actually will continue to utilize REITs going forward. We had a couple of different questions that asked about behavior around COVID, and everyone is very positive buy-and-hold investors going forward. But I think what was interesting about that research and this goes back, Matt, to your question of what do they site is the number 1 reason for investing in REITs? It really is portfolio diversification. I think the more we interact with and understand the various investment cohorts and how they are utilizing REITs, it consistently comes back to portfolio diversification. Again, the strong long-term performance and both the income and capital appreciation is really important to investors, and they see that REITs play that role. Of course, not making up 50 percent of your portfolio, but in that range of 5-15 percent. There's a lot of great information on reit.com, which is the Nareit's website. There an investor can not only drill down and understand more about what I've talked about here, access some of these studies that I've talked about, but also we have a section where people can actually dig in and start to look at the various companies or funds or ETFs that are offered in this space. We have a lot of information out there. We also have a partnership with FTSE Russell where we provide benchmarks both globally and for the US. If investors are just curious to do a quick snapshot of how the industry is performing today, they can also access all of that information from our website. A wealth of information and resources for investors that we hope that all of the Fool listeners here will definitely access going forward.

Matt Frankel: I'm glad you mentioned some of that. First of all, REITs aren't supposed to be 50 percent of my portfolio. [laughs] I Might be doing this wrong.[laughs] I just want to mention to the audience that the sector performance tools are excellent. If Deidre and I want to figure out say how retail REITs have done over the past year, there's pretty much no other way to find it but you guys, so I want to say thanks for that kind of help. The educational resources on reit.com are just amazing. When we launched Millionacres, I wrote a 3,000-word document on what are REITs and that was my primary source, so thanks. But I wanted to pivot to one thing, we've talked about a bunch of different types of REITs. I wanted to pivot toward one of my favorites, which is office REITs for just a second if we can. I feel like, I'm the only person in the world who likes office REITs anymore or who thinks that we're going to work in offices after the pandemic and want to go places and things like that. I know you will hold a lot of events, is another thing that Nareit does, and they've all been virtual, obviously, and are going to be virtual for a little while. Do you see in-person demand for group travel, and things like that, and office work? Where do you see all that going in the next few years? Do you think, it's going to be like a quick snapback in those cases because you mentioned leisure travel will come back quickly, business travel, not so much. When it comes to business activities, meaning, travel and office work, do you think it's going to be more of a gradual climb over the next few years or how do you see that playing out?

Abby McCarthy: I think it's still a little early to tell. I am encouraged by the vaccine rollout. I want to say today, I even heard the statistic that 50 percent of American adults now have received at least one shot of the vaccine. That is very positive news for, obviously, the country in general, but also for real estate and for office real estate. There's a lot of speculation right now in terms of what the work-from-home movement that happened in the pandemic is really going to mean for the long-term. I think it's probably a little bit too early to tell. I think, there are few time periods where I think, we'll get more information. I think that by this summer, as we see the vaccination rollout continues, especially now, I live in the Washington DC area, and here, obviously, they've opened up for every adult now has access, I think that actually is countrywide, to the vaccine. I think by this summer, it'll be interesting to see if people start returning to the office with a little bit more regularity. I think, the real key date though, to watch will be Labor Day. I think after Labor Day, if we see kids return to schools, I think, it'll be interesting to see how much movement we see back into the office. Now, I think most people anticipate that there will be a move back to the office. Now, what that will look like? I think, will be interesting to see. Right now, obviously, there's some major corporations that have talked about hybrid models and bringing people back into the office that maybe only a couple of days of week. It seems like that might be what we see more in the short term. I'm not sure over the long-term, how much that will come to be. It does seem like in major business hubs, in major areas, there is still a desire, and a demand for people to congregate, and be together, and collaborate not only for office culture, but also to be able to effectively train new employees, and to integrate people into office culture first. I think that over the next year, we're going to see a lot of different scenarios play out. But my sense is, over the long-term, more people will be back in the office than anticipated today, but it's still a little too early to make that prediction.

Matt Frankel: That's fair enough, that's about right.

Abby McCarthy: [laughs] Yeah? Again, I think as people become more comfortable with public transportation, and with the ability to get back into the office in a safe and comfortable way where they're comfortable around their coworkers. People change quickly and I think that what we've seen, and obviously, we've never lived through a pandemic before but in other downturns in the real estate market that there has been a resiliency. I think, there is longer-term demand for people to congregate in a central location.

Deidre Woollard: I like what you said about the hybrid. I'm wondering if you see something similar happening in retail to some extent. Last year, obviously, industrial was a pretty strong area for REITs, retail e-commerce shot up. Now, we've got, I feel like we have a little bit of a hybrid situation in retail where people are using e-commerce more, but they're also slowly starting to go back to shopping in-person and actually enjoying that. Is that a trend you think is going to be continuing?

Abby McCarthy: That is what we're seeing in the data that the foot traffic in malls and obviously, a regional mall is going to be very different than your local shopping center, which you've probably been accessing through the pandemic, maybe not in the ways that you were before. But again, I think as those retailers and a lot of, especially, in the shopping center REITs, a lot of that is made up by restaurants as well as those businesses have been able to open up more and to be able to do it safely. I think, we've seen a real increase in traffic. I do see too that there's real pent-up demand like while we've all been ordering our groceries and every day is Christmas in my house when the Amazon [laughs] boxes show up. But there is a real pent-up demand to be able to get back out there and to go to restaurants, and to engage with our communities, and to engage with our products. I do see that, I don't think there's going to be a slowdown in e-commerce. I think that that's proved itself as a model that we like the fast, easy way of getting our products delivered to us for most things, but not for all. I do see that the demand for retail space for engaging with a shopping mall or engaging with the shopping center will increase as people feel safer and are vaccinated then we reach a point where we have a little bit more herd immunity.

Deidre Woollard: Yeah, absolutely. I think that in some ways, it's still a little soon to tell what's happening. One other question I wanted to ask you about REITs in general is, are there any other emerging sectors in REITs that you're tracking? Obviously, you track different sectors, but is there anything that's coming down the pike in terms of other types of REITs that maybe don't fit into one of the specific categories that you look at?

Abby McCarthy: I think, really what's dominated I would say, the new REIT space over the past couple of years has definitely been the increase in market share that some of the newer sectors that are already in existence have. There, I'm talking again about cell towers and data centers. Outside of that, I don't see anything new on the horizon that's not already in existence. As I mentioned at the beginning of our discussion, single-family rentals, I think that particular sector is seeing increased demand and that didn't even exist before 2008. The single-family rentals sector in the REIT space is very new. Those management teams have figured out really how to create a business model across a large portfolio of single-family homes that has worked and that obviously in the need and the demand for housing right now, I think, is very well situated. Data centers are still relatively new when you're talking about the real estate space if something that's five years old, is still brand new. I still see tremendous growth in emergence of portfolios and properties in that sector. I think those are really the ones to watch. That's the new frontier of REIT property types that I think have proved to be strong performers in the pandemic. I think, there's something to watch going forward.

Deidre Woollard: Fantastic. This was great. I really appreciate your time and for sharing your REIT expertise with our listeners.

Abby McCarthy: Great. Thank you for having me. It's been great to talk with you. Again, I hope that your listeners definitely take a look at reit.com and feel free to reach out. There's a lot of resources there to help you navigate how to invest and where to invest in REITs.

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