Technology stocks act like growth stocks. Materials firms behave like value. That sectors tend to overlap heavily with investment styles is relatively common knowledge. Yet those simple observations don’t tell you everything you need to know: They show what happens, but not why—and the latter is crucial to understanding and assessing which categories and areas may lead markets. Growth stocks’ uncharacteristic leadership since this bull market began last March is a prime example, as applying surface-level observations of value’s traditional early leadership would have set investors behind. But sectors’ and countries’ behavior can also change over time. The Real Estate sector appears to be undergoing such a shift today.
It isn’t unprecedented for sectors to undergo style shifts. One classic example is Consumer Staples. Widely considered a value-heavy sector today, it acted much more growth-like in the 1960s and 1970s, when many Staples were part of the “Nifty Fifty.” (Hence, the Nifty Fifty’s slogan: “Growth at any price.”) Back then, Staples firms benefited from expansion into new international markets and wildly popular product development. Procter & Gamble introduced household mainstays like Pampers disposable diapers, Head and Shoulders shampoo, Crest toothpaste and Downy detergent (along with memorable ad campaigns). Coca-Cola took diet soda mainstream with Tab, and Gillette made shaving less painful with the first silicone-coated razors. This innovation provided Staples product differentiation, driving profitability relative to the market and making the sector act much more growthy than it does today. But over the ensuing decades, the Consumer Staples sector matured, changing as products became more commoditized and international market penetration increased.
A similar shift may be occurring today in the Real Estate sector, as new sub-industries have more growthy characteristics. First, understand: All REITs aren’t created equal. While both publicly traded and non-traded REITs offer diversification beyond what most investors can achieve through direct investment in physical real estate, non-traded REITs tend to have much higher fees and a lot less liquidity than their publicly traded counterparts. Non-traded REITs often lock in investors until specified redemption windows, whereas listed REITs trade much like stocks, only with the requirement to pass through 90% of earnings to investors via dividends to maintain their exemption from corporate taxes.
Those big dividends are characteristic of value, which is why most people just assume REITs are categorically value stocks. Historically, that was accurate. You can see this in the correlation coefficient, a statistic measuring how much two variables tend to move together. At the end of 2000, REIT returns relative to broader markets had a 0.79 correlation to value returns relative to growth over the previous 3 years.[i] Identical movement is 1.00 and exact opposite is -1.00, so 0.79 implies REITs and value outperformed concurrently much more often than not—outperforming together and vice versa. But by the end of 2020 that rolling 3-year correlation had dropped to 0.32.[ii] That still implies they outperformed at the same time more often than not, but the correlation is much, much weaker.
This historic correlation makes sense when you consider REITs’ dominant subindustries back then. It leaned heavily toward Retail and Office, which are economically sensitive—just like value stocks. Their revenue growth typically hinged on broader economic growth. In 2009, the earliest year we have sub-industry composition, Office, Retail and Lodging combined for 43% of US REITs’ market capitalization.[iii] Today, they are down to 21%. Taking their place are Tech-related sub-industries—REITs with much more growthy characteristics.
One example: Data centers. Data-storage needs have expanded, driven by areas like cloud computing and increased remote work. Supporting this requires massive servers living in large commercial spaces, and data-center REITs have mushroomed. Warehouse REITs have also benefited from Tech-like industries’ expansion, thanks to e-commerce. These warehouses are crucial to growing supply chains and online retailers’ increasing focus on “last mile” delivery, as companies look to reduce shipping times. Additionally, cell phone tower REITs have benefited from all things mobile and 5G technology, as these companies rent out space on their towers to Telecom companies. Together, these groups are now 35% of Real Estate’s market cap.[iv] Since all these sub-industries stem from growth-oriented, Tech-related industries, they tend to be much less value-like. This, in our view, is behind the shift in correlations and the sector’s increasingly mixed style.
While we still consider Real Estate overall a value sector, we think the ascendant growth-like subindustries illustrate the importance of digging into sectors and exploring why stocks behave as they do. If you avoid REITs entirely when growth leads because of their value reputation, you just might miss some overlooked growth opportunities. That is why it is always important to understand the causation behind the correlation.
[i] Source: Factset, as of 8/13/2021. 36-month correlation between weekly FTSE Nareit All REIT Price Return minus Russell 2500 Price Return and weekly Russell 2500 Value Price Return minus Russell 2500 Growth Price Return, 12/26/1997 – 12/29/2000.
[ii] Source: Factset, as of 8/13/2021. 36-month correlation between weekly FTSE Nareit All REIT Price Return minus Russell 2500 Price Return and weekly Russell 2500 Value Price Return minus Russell 2500 Growth Price Return, 12/29/2017 – 12/25/2020.
[iii] Source: reit.com, as of 8/13/2021. FTSE Nareit US Real Estate Index Series Monthly Constituents, 12/31/2009 and 12/31/2020.
[iv] Source: reit.com, as of 8/13/2021.FTSE Nareit US Real Estate Index Series Monthly Constituents, 12/31/2020.
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