{"id":1004262803,"date":"2018-09-05T08:29:02","date_gmt":"2018-09-05T16:29:02","guid":{"rendered":"https:\/\/www.commercialsearch.com\/news\/?p=1004262803"},"modified":"2022-12-06T13:26:11","modified_gmt":"2022-12-06T21:26:11","slug":"structural-features-boost-reit-long-term-performance","status":"publish","type":"post","link":"https:\/\/www.commercialsearch.com\/news\/structural-features-boost-reit-long-term-performance\/","title":{"rendered":"Structural Features Boost REIT Long-Term Performance"},"content":{"rendered":"

By Calvin Schnure<\/p>\n

\"\"

Calvin Schnure<\/p><\/div>\n

It\u2019s pretty well known that REITs have enjoyed strong performance<\/a> over the past 25 years, despite short-term zigs and zags along the way. What is less well known are the structural features that help deliver this performance. With the adage that past performance doesn\u2019t guarantee future returns in mind, let\u2019s examine two of these features, as they may continue to be a tailwind for REITs.<\/p>\n

First, REITs are an efficient, low-cost structure for managing commercial real estate, and second, most REITs align management incentives closely with shareholders\u2019 interests, motivating them to maximize value for the shareholders.<\/p>\n

The general and administrative expenses (G&A) of owning and operating a portfolio of commercial buildings were less than one percent of total book assets for the typical REIT in 2017. This is a bargain, as compared to fees charged under the private equity real estate \u201c2 & 20\u201d model. Managers of these funds typically take fees of up to two percent of assets under management (AUM), plus an incentive based on performance\u2014often 20 percent of the return above a hurdle rate.<\/p>\n

\"\"

Sources: Company reports, S&P Global Market Intelligence, Nareit<\/p><\/div>\n

That is, private equity real estate funds charge two to three times what REITs require to manage the same types of properties. These cost savings of two percent of assets boost returns for REIT investors.<\/p>\n

REITs also achieve significant economies of scale. Among REITs with book assets over $5 billion, the median G&A charges were 72 basis points of total assets, as compared to nearly 120 bps for the median REIT with assets below $1 billion.<\/p>\n

\"\"

Sources: Company reports, S&P Global Market Intelligence, Nareit<\/p><\/div>\n

The second feature favoring REITs is an incentive structure that motivates management to pursue investors\u2019 interests. Consider first the private equity \u201c2 & 20\u201d model. Managers receive 2 percent of AUM, but only if they actually deploy investors\u2019 capital by buying properties. What if a fund raises money but has concerns that property values are overheating? The fund managers could hold the money in cash until they believe property values were more reasonable. But then they don\u2019t get paid! Alternatively, they could buy properties despite concerns about overpaying. This creates the risk that private equity real estate fund managers pay top dollar to buy at the peak of the market.<\/p>\n

The \u201c2 & 20\u201d model has another potential conflict between the interests of managers and the investors in the fund. Management gets 20 percent of the upside over the hurdle rate, but don\u2019t lose out for declines below the hurdle rate. This \u201cheads-I-win, tails-you-lose\u201d compensation may lead to excessive risk<\/a> in the fund investments, as fund managers get a chunk of the upside but investors lose if the gamble doesn\u2019t work out.<\/p>\n

Most REITs do not suffer from these types of conflicts between management and investors because they offer compensation that aligns the interests of management with investors. Instead of pay packages based on AUM or offering stock options\u2014which have the same \u201cheads-I-win, tails-you-lose\u201d incentive for choosing riskier investments as the \u201c2 & 20\u201d model\u2014most REITs offer shares in the company to the CEO and management team. Management thus gets the same payoff as outside investors and is motivated to act in their best interests. These stock grants typically must be held for several years, keeping management in the game for the long haul.<\/p>\n

\"\"

Sources: Company reports, S&P Global Market Intelligence, Nareit<\/p><\/div>\n

Nearly 90 percent of REITs provide incentive compensation<\/a> to management exclusively through restricted stock (the right bar in the final chart). This ensures that management acts in the best interests of investors. Efficient management and alignment of incentives are features boosting the long-term performance of REITs.<\/p>\n","protected":false},"excerpt":{"rendered":"

These companies’ efficient, low-cost structure, as well as successful alignment of management incentives with shareholders\u2019 interests, continues to provide tailwinds to the sector, according to Nareit Senior Vice President of Research & Economic Analysis Calvin Schnure.<\/p>\n","protected":false},"author":1418,"featured_media":1004262839,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"_jetpack_memberships_contains_paid_content":false,"footnotes":""},"categories":[37301,21684],"tags":[41921],"class_list":["post-1004262803","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-uncategorized","category-viewpoint","tag-nareit"],"acf":[],"yoast_head":"\nStructural Features Boost REIT Long-Term Performance - Commercial Property Executive<\/title>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/www.commercialsearch.com\/news\/structural-features-boost-reit-long-term-performance\/\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"Structural Features Boost REIT Long-Term Performance\" \/>\n<meta property=\"og:description\" content=\"These companies' efficient, low-cost structure, as well as successful alignment of management incentives with shareholders\u2019 interests, continues to provide tailwinds to the sector, according to Nareit Senior Vice President of Research & Economic Analysis Calvin Schnure.\" \/>\n<meta property=\"og:url\" content=\"https:\/\/www.commercialsearch.com\/news\/structural-features-boost-reit-long-term-performance\/\" \/>\n<meta property=\"og:site_name\" content=\"Commercial Property Executive\" \/>\n<meta property=\"article:publisher\" content=\"https:\/\/www.facebook.com\/CPExecutive\" \/>\n<meta property=\"article:published_time\" content=\"2018-09-05T16:29:02+00:00\" \/>\n<meta property=\"article:modified_time\" content=\"2022-12-06T21:26:11+00:00\" \/>\n<meta name=\"author\" content=\"Calvin Schnure\" \/>\n<meta name=\"twitter:card\" content=\"summary_large_image\" \/>\n<meta name=\"twitter:image\" content=\"https:\/\/www.commercialsearch.com\/news\/wp-content\/uploads\/sites\/46\/2018\/09\/Schnure_Calvin.jpg\" \/>\n<meta name=\"twitter:creator\" content=\"@cpexecutive\" \/>\n<meta name=\"twitter:site\" content=\"@cpexecutive\" \/>\n<script type=\"application\/ld+json\" class=\"yoast-schema-graph\">{\"@context\":\"https:\/\/schema.org\",\"@graph\":[{\"@type\":\"WebPage\",\"@id\":\"https:\/\/www.commercialsearch.com\/news\/structural-features-boost-reit-long-term-performance\/\",\"url\":\"https:\/\/www.commercialsearch.com\/news\/structural-features-boost-reit-long-term-performance\/\",\"name\":\"Structural Features Boost REIT Long-Term Performance - 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