Real Estate can be a challenging sector for value investors, in part because valuations for this group, on a cash-flow basis, tend to be higher than other areas of the market. At the same time, Real Estate Investment Trusts (REITS), the largest component of the sector, have been lagging the broader market since 2022, owing to higher interest rates, a potential oversupply of apartments, and work-from-home policies weighing on office building valuations.
While the chart below highlights these recent struggles, we also think it depicts why it makes sense to have exposure to Real Estate in our portfolios. The chart illustrates the performance of REITs relative to value stocks since the end of 2004. When the line is falling, as has been the case since 2022, REITs trailed the broad market. But when the line is climbing, that signals periods when REITs have outperformed. As the chart indicates, over the last 20 years, there have been at least five multi-year rallies in this group.
Predicting the future is impossible, and these headwinds may persist. However, the fact that REITs have underperformed for such a long stretch may indicate the trend will eventually reverse — for long-term investors who are patient. We don’t believe it makes sense to be underweight a sector that makes up 10% of the Russell 2000 Value Index, especially when we can find undervalued Real Estate stocks that fit our 10 Principles of Value Investing™.
Source: FactSet Research Systems, Inc., Monthly data 11/30/2004 to 10/31/2024. The data in this chart represents the S&P Composite REITS Total Return in relation to the Russell 3000 Value Total Return. All indices are unmanaged. It is not possible to invest in an index. Past performance does not guarantee future results.
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