Review of Q3 Market and Fund Performance
Global real estate stocks posted losses in the third quarter of 2023, as multiple exogenous factors weighed on the capital markets, such as central bank tightening to rein in inflation, the war in Ukraine, China’s muted recovery and the potential for a protracted strike by the UAW. These factors 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 -5.59% for the quarter, while the Easterly Global Real Estate Fund (the “Fund”) generated a total return of -4.98%, outperforming the Index by 61 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, 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 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 portfolio, 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 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 fund 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 world order 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.
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.
Attribution of the Fund’s Q3 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 Net Lease sector was a contributor to relative returns vs. the benchmark, resulting from our underweight allocation and stock selection. The Fund also benefited from its underweight and stock selection in the Data Centers and Self-Storage sectors and its overweight and stock selection in the Student Housing and Residential sectors.
The Fund’s stock selection in the Cell Towers, Office, and Health Care 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 84 basis points)
- DigitalBridge, a manager of digital infrastructure assets, has simplified its business and nearly completed its rotation into a capital light manager of Digital Infrastructure, a multi-year project.
- DBRG outperformed as the prospect for capital raising for digital infrastructure, which was already strong, has brightened further with the excitement around AI which could drive DBRG to exceed its short- and medium-term fundraising goals providing upside to earnings expectations.
Mitsubishi Estate Company, Limited (8802 JP – contributed 72 basis points)
- Mitsubishi Estate is one of the largest real estate owners and developers in Japan, with some exposure to overseas markets as well.
- The substantial capital rotation from Hong Kong/China into Japan was the primary catalyst for material outperformance with the large Japanese developers receiving the most buy pressure (Index +10.4% in Q3). Further, rising inflation and the re-opening of Japan (post COVID) all provide significant upside to earnings estimates in conjunction with the market pricing in higher cash flow multiples vs. historically depressed low levels.
TAG Immobilien AG (TEG GY – contributed 34 basis points)
- TAG Immobilien is a residential landlord with a portfolio of 87,000 affordable apartments across Germany and a residential development business in Poland.
- TAG’s solid balance sheet post rights issuance (2022), asset sales success, strength in Poland and strong operational performance in German residential, taken together, drove strong stock price appreciation during the quarter.
Vonovia SE (VNA GY – contributed 32 basis points)
- Vonovia is a residential company in Germany that has benefited from solid German residential operational performance coupled with recent success of asset sales and the market’s optimistic view on potential balance sheet repair.
Notable individual detractors from the portfolio’s performance in the quarter include:
Cellnex Telecom S.A. (CLNX SM – detracted 60 basis points)
- Fundamentals in the European tower sector remain robust (inflation-protected long leases providing a growing and visible cash flow stream) while fundamentals in most other real estate sectors are under pressure
- While fundamentals remain strong, higher interest rates in Europe & the UK and modestly expanding credit spreads have created concern among investors that large asset and portfolio sales will be delayed into 2024-2025. Cellnex’s deleveraging plan considers portfolio sales and joint ventures to achieve their leverage target by the end of 2024.
Independence Realty Trust, Inc. (IRT – detracted 48 basis points)
- Independence Realty Trust, Inc. is a multi-family REIT with properties across non-gateway U.S. markets.
- The shares underperformed as supply concerns grew in the Sunbelt, recession fears rose, and rent growth continued to moderate off record levels. IRT has higher leverage than peers in a sharply rising rate environment which has also been a headwind.
UDR, Inc. (UDR – detracted 43 basis points)
- UDR, Inc. is a U.S. REIT that owns and manages multi-family communities.
- UDR has underperformed as supply concerns grew in the Sunbelt, recession fears rose, and rent growth continued to moderate off record levels.
Link Real Estate Investment Trust (823 HK – detracted 33 basis points)
- Link REIT is the largest Asian REIT with a portfolio predominantly comprised of grocery anchored shopping centers across Hong-Kong, China, Australia, and Singapore.
- The shares underperformed in Q3 due to continued negative sentiment related to HK/China landlords (index down -12.6% in Q3). 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.
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 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 fixation on non-fundamental factors, we believe our portfolio is well positioned as investor attention turns back to fundamentals.
| 9/30/2023 | QTD | YTD | 1-YEAR | 3-YEAR | 5-YEAR | 10-YEAR | SINCE INCEPTION 8/1/2011 |
|---|---|---|---|---|---|---|---|
| I Shares | -4.98% | -4.76% | 1.98% | 0.90% | 0.80% | 4.38% | 5.43% |
| Morningstar Global Real Estate Category | -5.48% | -4.23% | 2.83% | -0.26% | -0.59% | 2.25% | 2.78% |
| FTSE EPRA Nareit Developed Index | -5.59% | -4.10% | 2.72% | 1.53% | -0.30% | 2.97% | 3.95% |
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 March 31, 2024 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 March 31, 2024 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. Effective 10/2/2023, the Easterly mutual funds are distributed by Easterly Securities, LLC. Easterly Investment Partners, LLC and EAB Risk Solutions, LLC are affiliates of Easterly Securities, LLC, member FINRA/SIPC. Orange Investment Advisors, LLC and Ranger Global Advisers are not affiliated with Easterly Securities, LLC. Certain associates of Easterly Securities, 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 serves as the Advisors to the Easterly Fund family of mutual funds and related portfolios. Easterly Funds, LLC is registered as investment advisers with the SEC. Effective 10/2/2023, the Easterly mutual funds are distributed by Easterly Securities, LLC. Although Easterly Funds, LLC is a registered investment adviser, 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.
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