Review of Q2 Market and Fund Performance
Global real estate stocks posted slight gains in the second quarter of 2023, as multiple exogenous factors weighed on the capital markets (e.g., central bank tightening to rein in inflation, the war in Ukraine, China’s transition from COVID lock-downs to re-opening its economy and the regional bank mini-crisis) continued to distract investors, causing them to keep their attention focused mostly away from industry and company fundamentals. The FTSE EPRA Nareit Developed Index (the “Index”) had a total return of 0.54% for the quarter, while the Easterly Global Real Estate Fund (the “Fund”) generated a total return of 0.44%, underperforming the Index by 10 basis points.
A historical review of listed real estate returns during periods of high inflation serves as a reminder that real estate values tend to increase with inflation, as rising inflation is typically consistent with a growing economy – the most important driver of demand for most property types. Additionally, commercial real estate leases often incorporate annual rent escalators, helping to provide additional protection of real estate cash flows during inflationary periods.
Higher energy prices, particularly in Europe, may reduce consumer spending and negatively impact sectors exposed to discretionary spending. Notably, the Fund is positioned defensively in Europe, with a substantial portion of its European holdings invested in German residential companies, whose fundamentals are not only unimpacted by rising energy prices but are in fact bolstered by increased demand for housing, spurred by the tide of migrants fleeing Ukraine. Other European positions are similarly insulated from the economic fallout of the conflict in Ukraine, with Specialty property type positions (e.g., Cell Towers, Student Housing and Medical Office Buildings) representing the bulk of the Fund’s remaining European exposure.
Regional Bank Stress
The regional bank mini-crisis, thus far, has revealed the lagged effect of rate hikes to date—and the resulting duration mismatch that created an inherent instability among the deposit base. Uncertainty among lenders over the regulatory response (what adjustments if any will be made to the current $250k per account FDIC insurance limit) will likely have a chilling effect on their willingness to make new loans and/or re-finance existing ones.
The flipside is that the resulting tightening of credit will do some of the Fed’s work for it, thus shifting the narrative around future rate hikes from “higher for longer” to “just high for longer.” Thus, the path forward in terms of potential impact on the business of commercial real estate will be determined largely, if not solely by the Fed and the Treasury acting in concert to contain and thus prevent the isolated challenges at a small number of regional banks from evolving into widespread contagion that could present a systemic challenge.
Listed REITs enjoy access to all four quadrants of the capital markets (public and private, debt and equity), providing them with greater access to capital than is typically available to their private real estate counterparts. Moreover, public REITs typically operate with lower leverage than do most private real estate companies – thus further insulating them from any disruptions in the capital markets. Accordingly, any stress that emerges in the regional banking system will no doubt have greater impact on private real estate companies than on public real estate companies.
As to the implications or ramifications for the Fund, we have evaluated all companies owned with an eye toward identifying any that have near-term re-financing risk. We have determined that none of the companies owned in the portfolio have any potentially challenging debt maturities until 2025. As a further test we evaluated each company’s exposure to variable-rate debt and determined that none of the companies owned in the portfolio have an amount that exceeds our comfort level as well as prudent amounts that are consistent with their capital formation cycles and overall financial flexibility.
Finally, as it relates to the highly challenging outlook for office buildings- particularly those located in Central Business Districts-, the impact of fundamental changes in how companies manage their office space needs in the new business environment of hybrid work models, owners of office buildings will experience significant headwinds over the next five plus years as existing leases expire and tenants downsize their space needs. The ensuing erosion of value will in some ways be similar to the secular decline in regional malls resulting from the “Amazon effect,” i.e., the disruptive impact of e-commerce. Just as the commercial real estate industry writ large managed to thrive in the face of substantial value destruction in the regional mall sector (which at one time had a larger market capitalization than the office sector), it is certainly plausible that the coming difficulties in the office sector can be contained without spreading to other sectors or the funding markets for commercial real estate.
Attribution of the Fund’s Q2 2023 Performance
Key contributors and detractors to the Fund’s relative performance over the second quarter are outlined below:
The Fund’s positioning in the Residential sector was a contributor to relative returns vs. the benchmark, resulting from our overweight allocation and stock selection. The Fund also benefited from being underweight and stock selection in the Diversified, Industrial and Self-Storage sectors and its overweight and stock selection in the Cold Storage sector.
The Fund’s stock selection in the Manufactured Home Communities, Data Centers and Student Housing sectors detracted from relative returns. We believe that the sell-off in Specialty property types with strong growth prospects due to the paradox of higher-growth when interest rates rise has presented attractive value investment opportunities for the Fund.
Notable individual contributors to the portfolio’s performance in the quarter include:
DigitalBridge Group Inc. (DBRG – contributed 54 basis points)
- DigitalBridge is a manager of digital infrastructure assets (data centers and cell towers).
- The company outperformed in Q2 as excitement over AI increased which could increase the amount of capital formation DigitalBridge is able to achieve in the near term.
Next DC Limited (NXT – contributed 53 basis points)
- Next DC is a large data center developer, landlord and operator in Australia.
- The company outperformed in Q2 due to the announcement of significant contracted leasing, increasing contracted megawatts (MW) by nearly 50%. Management further signaled likely incremental leasing announcements over the short term. The company also issued primary equity to finance further data center development and land acquisition.
Ellington Financial Inc. (ELC – contributed 40 basis points)
- Ellington Financial is a mortgage REIT that specializes primarily in consumer and residential credit investments.
- The company outperformed in Q2 as they maintained a steady book value and announced the accretive acquisition of a smaller competitor that will increase scale and profitability.
TAG Immobilien AG (TEG GY – contributed 40 basis points)
- TAG is a residential landlord with a portfolio of 87,000 affordable apartments across Germany and a residential development business in Poland.
- The company has made good progress alleviating leverage and liquidity concerns by disposing of assets in a difficult and illiquid transactions market. In addition, TAG organized a well-attended Capital Markets Day in Poland to showcase its recently acquired Polish residential development business, which is benefiting from a new mortgage subsidy program for first-time buyers.
Notable individual detractors from the portfolio’s performance in the quarter include:
Link Real Estate Investment Trust (823 HK – detracted 67 basis points)
- Link REIT is the largest Asian REIT with a portfolio predominantly composed of grocery anchored shopping centers across Hong-Kong, China, Australia, and Singapore.
- The shares underperformed in Q2 due to continued negative sentiment related to HK/China landlords (index down 11.7% for the quarter). While Link REIT has recapitalized post rights issuance with a strong balance sheet, the market continues to discount earnings and dividend growth as LINK has yet to invest the capital raised.
Instone Real Estate Group SE (INS GY- detracted 52 basis points)
- Instone is one of the largest residential developers in Germany.
- The shares, which are relatively illiquid, suffered from the selling pressure of a 3% shareholder, in addition to operational fundamentals which remain difficult due to the sharp increase in mortgage rates in Germany. Nonetheless, we believe that the selling shareholder has now completely exited its position.
Sun Communities Inc. (SUI – detracted 26 basis points)
- Sun Communities is an owner of manufactured housing communities and marinas in the USA as well as holiday parks in the UK.
- The company underperformed in the quarter as it cut its expectations for home sales in the UK business during its quarterly earnings report, raising investors’ concerns around this new business line’s predictability.
SBA Communications Corp. (SBAC – detracted 19 basis points)
- SBAC is the third largest publicly traded tower REIT with more than 17,000 towers in the US and 39,000 towers globally.
- SBAC and the tower stocks were pressured in 2Q by rising interest rates and by a DISH announcement. Specifically, DISH announced that after meeting its 2023 build-out deadline it would pause work towards its 2025 deadline until late 2024 at the earliest. Dish is a relatively small customer for SBAC but its build-out has boosted growth and a slowing of that activity raising concerns that it will slow the pace of growth in the near-term.
Despite the macroeconomic and geopolitical stress that is capturing headlines, our outlook for the global real estate market continues to be constructive. Real estate fundamentals and earnings growth remain healthy in an environment characterized by low supply in many sectors, paired with high construction costs.
Our high conviction, benchmark-agnostic investment approach allows us to maintain a laser-focus on identifying and owning only the 50 highest-quality companies in our investable universe. We have high conviction in our fundamental research and confidence in the management teams of the companies we own. While global capital markets continue to experience periods of market fixation on non-fundamental factors, we believe our portfolio is well positioned as investor attention turns back to fundamentals.
|Morningstar Global Real Estate Category||0.21%||1.31%||-4.56%||2.32%||0.06%||2.80%||3.42%|
|FTSE EPRA Nareit Developed Index||0.54%||1.58%||-3.59%||4.30%||0.83%||3.81%||4.54%|
Past performance does not guarantee future results and current performance may be lower or higher than the performance data quoted. The investment return and principal value of an investment will fluctuate, so that shares when redeemed may be worth more or less than their original cost. Investors cannot invest directly into an index. For performance information current to the most recent month-end, please call 888-814-8180.
SOURCE: Morningstar Direct. Performance data quoted above is historical.
The Fund’s management has contractually waived a portion of its management fees until December 31, 2023 for I, A, C and R6 Shares. The performance shown reflects the waivers without which the performance would have been lower. Total annual operating expenses before the expense reduction/reimbursement are 1.11%, 1.36%, 2.11% and 1.11% respectively; total annual operating expenses after the expense reduction/reimbursement are 1.04%, 1.36%, 2.11% and 0.94% respectively. 5.75% is the maximum sales charge on purchases of A Shares.
The Fund’s investment adviser has contractually agreed to reduce and/or absorb expenses until at least December 31, 2023 for I, A, C and R6 Shares, to ensure that net annual operating expenses of the fund will not exceed 1.04%, 1.69%, 2.37% and 0.94%, respectively, subject to possible recoupment from the Fund in future years.
The FTSE EPRA Nareit Developed Global Real Estate Index is comprised of publicly-traded REIT securities in developed countries worldwide which have met certain financial criteria for inclusion in the Index. Each company must derive the bulk of its earnings through the ownership, management or development of income-producing commercial real estate.
Investors should carefully consider the investment objectives, risks, charges and expenses of the Fund. This and other information is contained in the Fund’s prospectus, which can be obtained by calling 888-814-8180 and should be read carefully before investing. Additional Fund literature may be obtained by visiting www.EasterlyAM.com.
Risks & Disclosures
Past performance is not a guarantee nor a reliable indicator of future results. As with any investment, there are risks. There is no assurance that any portfolio will achieve its investment objective. Mutual funds involve risk, including possible loss of principal. The Easterly Funds are distributed by Ultimus Fund Distributors, LLC. Easterly Funds, LLC and Ranger Global Real Estate Advisors, LLC are not affiliated with Ultimus Fund Distributors, LLC, member FINRA/SIPC. Certain associates of Easterly Funds, LLC are registered with FDX Capital LLC, member FINRA/SIPC.
There is no assurance that the portfolio will achieve its investment objective. The Fund is subject to stock market risk, which is the risk that stock prices overall will decline over short or long periods, adversely affecting the value of an investment. Risks of one’s ownership are similar to those associated with direct ownership of real estate, such as changes in real estate values, interest rates, cash flow of underlying real estate assets, supply and demand and the creditworthiness of the issuer. International investing poses special risks, including currency fluctuations and economic and political risks not found in investments that are solely domestic. Incorporating alternative investments into a portfolio presents the opportunity for significant losses including in some cases, losses which exceed the principal amount invested. Also, some alternative investments have experienced periods of extreme volatility and in general, are not suitable for all investors. Asset allocation and diversification strategies do not ensure profit or protect against loss in declining markets.
Easterly Funds, LLC and Easterly Investment Partners, LLC both serve as the Advisors to the Easterly Fund family of mutual funds and related portfolios. Both Easterly Funds, LLC and Easterly Investment Partners, LLC are registered as investment advisers with the SEC. Mutual Funds are distributed by Ultimus Fund Distributors, LLC, a member of FINRA and SIPC. Although Easterly Funds, LLC and Easterly Investment Partners, LLC are registered investment advisers, registration itself does not imply and should not be interpreted to imply any particular level of skill or training.
As with any investment, there are multiple risks associated with REITs. Risks include declines from deteriorating economic conditions, changes in the value of the underlying property and defaults by borrowers, to name a few. Please see the prospectus for a full disclosure of all risks and fees.
THE OPINIONS STATED HEREIN ARE THAT OF THE AUTHOR AND ARE NOT REPRESENTATIVE OF THE COMPANY. NOTHING WRITTEN IN THIS COMMENTARY OR WHITE PAPER SHOULD BE CONSTRUED AS FACT, PREDICTION OF FUTURE PERFORMANCE OR RESULTS, OR A SOLICITATION TO INVEST IN ANY SECURITY.