Review of Q1 2023 Market and Fund Review
Multiple exogenous factors negatively impacted the capital markets during the first quarter of 2023; central bank tightening, inflation, the war in Ukraine 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 1.04% for the quarter, while the Easterly Global Real Estate Fund (the “Fund”) generated a total return of -0.21%.
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 high inflation is typically an indicator of 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 the 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.
Bank Stress
The “banking 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 refinance 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, faster and for longer” to “lower for shorter.” 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 most likely have greater impact on private real estate companies than on public real estate companies.
As to the implications or ramifications for the Fund’s holdings, 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 fund have any 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, the outlook for central business district (CBD) office remains highly challenging. The impact of fundamental changes in how companies manage their office space needs in the new world order of hybrid work models, owners of CBD office buildings will experience significant headwinds over the next few 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 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 CBD office can be contained without spreading to other sectors.
Attribution of the Fund’s Q1 2023 Performance
Key contributors and detractors to the Fund’s relative performance over the first quarter are outlined below:
The Fund’s positioning in the Cell Tower sector was a contributor to relative returns vs. the benchmark, resulting from our overweight allocation and stock selection. The Fund also benefited from its underweight and stock selection in the Office sector and its overweight and stock selection in the Data Center and Student Housing sectors.
The Fund’s stock selection in the Industrial, Self-Storage, and Net Lease sectors detracted from relative returns. We believe that the selloff in Specialty property types with strong growth prospects, such as Data Centers and Cell Towers, has created attractive value investment opportunities for the Fund.
Notable individual contributors to the portfolio’s performance in the quarter include:
Cellnex Telecom S.A. (CLNX – contributed 87 basis points)
- Cellnex is the largest European tower company with over 100,000 sites across 12 European countries.
- In Q1 Cellnex outperformed as it benefited from lower interest rates, but also from robust operations (long leases with inflation protection built-in) in an uncertain environment, M&A speculation, and the activist shareholder TCI disclosing a 9% stake and asking for a Board reshuffle (which could facilitate a take-over).
Next DC Limited (NXT – contributed 29 basis points)
- Next DC is a large data center developer, landlord and operator in Australia.
- The company outperformed in Q1 due to a combination of macro and company specific factors. In terms of macro, long-term interest rates declined by 100 bps, boosting the value of high growth / low current cash flow assets like Next DC. The company has grown increasingly confident in securing large commitments for some of its newly developed data centers, which the market progressively priced in.
Keppel DC REIT (KDCREIT – contributed 27 basis points)
- Keppel DC is a Singaporean-listed REIT with a diversified portfolio of 23 data centers across Asia Pacific and Europe.
- The shares outperformed in Q1 as the company benefited from lower long-term interest rates but also from the company specific issues of one of its Singaporean listed data centers peers, with capital being re-allocated to Keppel DC.
UDR, Inc. (UDR – contributed 16 basis points)
- UDR is an owner of multifamily apartment communities in the United States.
- UDR had robust performance in the quarter driven by better-than-expected initial earnings guidance because its geographical and asset type mix of apartments continued to have a strong demand. This strong earnings outlook coupled with a favorable valuation entering the year has driven outperformance versus apartment peers and the market more broadly.
Notable individual detractors from the portfolio’s performance in the quarter include:
Link Real Estate Investment Trust (823 HK – detracted 62 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 Q1 as the company surprised the market with a HK$19bn rights issue, with selling pressure resulting from dilution and the need from existing shareholders to sell some shares in order to raise cash to exercise their rights.
Mitsubishi Estate Company, Limited (8802 JP – detracted 46 basis points)
- Mitsubishi Estate is one of the largest developers in Japan, with some exposure to overseas markets as well.
- The shares underperformed in Q1 as the company revised its guidance modestly lower on the back of delayed disposals in its overseas business as well as lower fees in its asset management business (both the transaction market and capital raising activities have negatively been impacted by the sharp increase in interest rates in 2022).
Equinix, Inc. (EQIX – detracted 37 basis points)
- Equinix is a U.S. based global owner of data centers.
- The Fund was underweight Equinix, and the company performed in Q1 because of strong underlying trends in the business, that supported a below expectations but better than feared outlook for 2023.
Prologis, Inc. (PLD – detracted 35 basis points)
- Prologis is a U.S. based global owner of warehouse and logistics properties.
- The Fund was underweight Prologis, and the company had a positive return because business trends continue to exceed expectations. Demand continues to moderate from historically high levels, leading to slowing year-over-year growth. But that year-over-year growth has been better than feared.
Conclusion
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 strong in an environment characterized by low supply in many sectors, paired with high construction costs.
Our high-conviction, high active share fundamental investment approach allows us to maintain a laser-focus on seeking to identify 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 the Fund is well positioned as investor attention turns back to fundamentals.
| 3/31/2023 | QTD | 1-Year | 3-Year | 5-Year | 10-Year | Since Inception 08/01/2011 |
|---|---|---|---|---|---|---|
| I Shares | -0.21% | -21.88% | 8.51% | 3.13% | 4.59% | 6.09% |
| Morningstar Global Real Estate Category | 1.10% | -20.79% | 5.71% | 0.55% | 2.31% | 3.48% |
| FTSE EPRA Nareit Developed Index | 1.04% | -20.63% | 7.58% | 1.79% | 3.37% | 4.59% |
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
Effective 10/2/2023, the Easterly Funds are distributed by Easterly Securities LLC, member FINRA/ SIPC. Easterly Investment Partners LLC, FDX Capital LLC, and EAB Investment Group LLC are affiliates of Easterly Securities LLC. Certain employees of Easterly Securities LLC are registered with FDX Capital LLC. Orange Investment Advisers, LLC and Ranger Global Advisers, LLC are not affiliated with Easterly Securities LLC.
Not FDIC Insured–No Bank Guarantee–May Lose Value.
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.