Why these Lipper Award-winning fund managers think you need more real estate in your portfolio

The Globe and Mail

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Article by Paul Brent | Published on November 17, 2022

Canadian investors wanting to boost their real estate holdings should look to the country’s pension plans for a rough guide on how much of this asset class to own, says Michael Nairne, president and chief investment officer of Tacita Capital of Toronto.

“Pension plans have been adding real estate for years because they face what the average Canadian faces, which is a retirement funding challenge,” says Mr. Nairne, who manages the Lipper Award-winning TCI Premia Real Assets Private Pool fund. “Real estate offers an ability to build contracted cash flows that increase over time.”

Mr. Nairne explains that large pension operators have relied on their growing real estate holdings to provide much of the income that fixed income, such as bonds, used to provide. Pension providers currently hold roughly 10 per cent to 15 per cent real estate in their portfolios, Mr. Nairne says, and he believes individual investors would be wise to mirror that strategy.

Tacita Capital’s fund can take positions in individual real estate companies, real estate investment trusts (REIT) and exchange-traded funds (ETFs) that hold an array of REITs. Mr. Nairne believes ETFs may be the easiest option for individual investors seeking low-cost, diversified exposure to the real estate sector.

He says his fund offers potentially higher returns versus ETFs by overweighting particular companies and strategies.

The fund is down 13.6 per cent this year to Nov. 4 and returned nearly 32 per cent in 2021.

REITs have fared worse than the overall market during this year’s market downturn and are now trading roughly at a 20 per cent to 25 per cent discount to their net asset values.

“It’s a good time to enter” the sector, Mr. Nairne says, predicting the discount will disappear when market sentiment improves, and investors look to potentially hold their positions long term. REITs trade like a security over the short term, he says, and deliver benefits of real estate investments over the mid-to-long term.

Even with a long-term view, investors need to consider what’s happening in the broader economy, including cultural and workplace trends. For example, during the pandemic, office and traditional retail real estate valuations suffered while industrial real estate boomed alongside online shopping.

With remote and hybrid work the new norm, the office sector could face a tough future, says Steve Buller, a Boston-based portfolio manager with Fidelity Investments, who manages the Lipper Award-winning Fidelity Global Real Estate Fund. The Series F version of the fund is down nearly 24 per cent year to date as of Nov. 8 after rising 27 per cent last year. It made large annual gains most of the past decade.

The fund was recognized for its 10-year performance, starting with the hangover from the global financial crisis through a strong period for real estate and the pandemic. He and other portfolio managers are now navigating the choppy period of rising rates, inflation, and recession risks.

“Right now, we are more in what I call a balanced approach between sectors that are risk-off, growth [and] work from home. On the other side, risk-on value or reopening trade,” he says.

He says the less-risky side includes logistics, apartments, manufactured housing, data centres, and single-family rental. His focus includes non-mall retail, health care (in particular assisted living facilities), hotels and gaming REITs, a U.S.-only investment class.

Mr. Buller has been underweight office and retail real estate over the past decade, which has proven to be a good strategy.

“People forget office wasn’t a great business prior to the pandemic,” he says, adding the U.S. office market was suffering from a major supply glut even before COVID-19 hit, while retail has been slowly suffering from the shift to e-commerce shopping.

More exposure to hotels may seem risky given shaky economies in much of the western world; however, the Fidelity manager believes pent-up demand for both business and leisure travel will boost demand.

He says any stabilization of interest rates will signal stability in the sector, giving lenders, buyers and builders more certainty about spending their capital.

“Fundamentals and valuation are good or positive; it’s the capital side that is negative or the question mark … that’s pulling the performance down,” he says.

REITs are attractive at their bargain status and could appeal to investors with a strong stomach for volatility. Certain subsectors may also be more attractive than others.

Dean Orrico, president and chief executive officer of Middlefield Capital Corp. of Toronto, notes that industrial REITs have been among the hardest hit, down about 40 per cent so far this year, and may be oversold.

He notes many landlords are renewing leases at rates that are in line with inflation, which bodes well for future profits.

“As long as you have a good tenant base, and we are not seeing any cracks in that, so we think we are in good shape,” says Mr. Orrico, whose Middlefield Global Real Estate Dividend Class fund was a 2022 Lipper Award winner for five-year performance.

His fund’s winning strategy uses REITs to own 30 to 40 mainly Canadian real estate companies (with some U.S. and European firms), with strong fundamentals such as industrial, apartment and open-air, necessity retail centres.

The fund is down 24 per cent so far this year, as of Nov. 8 and gained more than 36 per cent in 2021.

Mr. Orrico believes many REITs are priced as though investors expect a recession as deep as the 2008-2009 global financial crisis, a view he doesn’t share. He points out that industrial rents fell about 25 per cent during the global financial crisis, while industrial firms are currently renewing leases about 20 per cent higher due to high demand.

Like other investors in the sector, Mr. Orrico sees real estate as a proven inflation hedge and an asset class that should be a part of most investor portfolios. Now is also a good opportunity to buy.

“[REITs] are down too much, and I think it represents great value,” Mr. Orrico concludes.

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