Changes to the Real Estate Lineup

Last quarter, the Aspiriant Investment Strategy and Research team completed a comprehensive review of our approach to publicly-traded real estate (REITs), which comprise up to 10% of many clients’ portfolios. We have divided the global real estate allocation, previously implemented using the RREEF Global Real Estate Fund (RRGIX), into US and non-US allocations, implemented with two different managers. We implemented these changes in clients’ portfolios in October.

US real estate allocations

We can ensure the best possible tax treatment for clients’ real estate investments by separating the US from non-US investments; consequently, we decided to split the real estate allocation into two separate funds.

For US real estate allocations, we have chosen the Cohen and Steers Institutional Realty Shares Fund (CRSIX). While we employ a systematic approach in most public asset classes, we have maintained a fundamental active approach in public real estate. Among other reasons, we think that there are important non-public sources of information about real estate (from private real estate investors, for example) which can be profitably incorporated by fund managers. After extensive conversations with RREEF and Cohen and Steers, we found the Cohen and Steers approach more compelling.

Cohen and Steers pioneered the field of REIT investing as the first investment manager dedicated to real estate securities, which has enabled their team to foster relationships with many of the largest public REITs over the course of many years. Cohen and Steers is often the largest investor in their portfolio companies and we believe this gives them the ability to exert their influence on the management teams of their portfolio companies. The clearest illustration of their influence in the industry came at the height of the financial crisis when Cohen and Steers orchestrated the recapitalization of several of the largest REITs. Initially opposed to Cohen and Steers’ suggestions, the REITs eventually came to an agreement with Cohen and Steers that recapitalization was vital to their subsequent survival and growth. As companies slowly worked to restructure their balance sheets, Cohen and Steers’ participation in the debt and equity offerings of the REITs provided a springboard that ultimately led to a quicker recovery. Over the past 20 years Cohen and Steers has generated consistently strong annualized returns in this strategy and has distinguished itself among its peers.

We still think highly of RREEF, which remains one of the largest investors in public and private real estate in the world. However, the RREEF approach in global markets became oriented toward analyzing countries and currencies as opposed to individual companies. This evolution was apparent in RREEF’s performance outside of the US, which showed good stock selection within countries but negative contribution from country and currency selection.

International real estate allocations

As we’ve written before, we believe that international real estate offers an outstanding growth opportunity in the coming decades. Much like US real estate 30 years ago, the vast majority of commercial real estate outside of the US is privately-owned and thus somewhat insulated from the competitive forces of the marketplace; consequently, much of that real estate is inefficiently managed and undervalued. The introduction of the REIT structure in the US over 30 years ago transformed the commercial real estate market, unleashing a great deal of value as real estate moved from private to public ownership. Many countries in Asia and Europe have created REIT-like structures, and we expect a similar dynamic to play out over the coming decades.

To access this opportunity, we have chosen the SPDR Dow Jones International Real Estate exchange traded fund (RWX), which mirrors the Dow Jones International Real Estate Index. While we acknowledge the non-public information in non-US real estate markets, we believe the geographic and currency risk of the non-US real estate space dominates managers’ ability to employ fundamental information. Active managers may be able to identify opportunities based on real estate fundamentals, but our experience suggests that they are not able to successfully allocate among countries and currencies (for which returns are driven by broader, macroeconomic factors). We have therefore decided to index the non-US exposure in order to minimize the management expense while maintaining market weight exposures around the world.

Tax considerations are always an important factor in our investment decisions, but they’re particularly important in real estate, which is among the most highly taxed investment asset classes. Most investments in foreign real estate receive particularly onerous tax treatment. We believe the compelling opportunities and benefits of diversification argue strongly for maintaining international real estate exposure despite this adverse tax treatment. To mitigate the tax issue we generally try to hold foreign REITs in clients’ tax-exempt accounts like IRAs and retirement plans. The exchange traded fund structure itself also helps to mitigate some of the onerous tax liability issues. An active manager using a traditional mutual fund format, in contrast, would face comparatively more tax liability issues.

Jason Thomas, Ph.D., CFA
Chief Investment Officer

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1 Goldman Sachs, "From the 'Great Recession' to the 'Great Stagnation'?", Global Economics Weekly, September 28, 2011.
2 Past performance is not indicative of future results.

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