Rising interest rates are a looming reality that will have a negative impact on virtually every financial instrument, but at least in the case of real estate, there is some hope for a hedge, according to Marc Halle, manager of the $2.3 billion Prudential Global Real Estate Fund (PURAX).
“If interest rates suddenly jump from 2% to 5%, there's nothing anyone can do,” he said. “But if we see modest increases associated with an improving economy and job growth, then real estate is very well-positioned to increase earnings and grow dividends.”
InvestmentNews: What are some important distinctions between investing directly in real estate and investing in real estate investment trusts?
Mr. Halle: Both are investments in real estate; it's just the taxation structure that's different.
When you invest in direct real estate, you're locking up your money for a long-term basis. You can target your opportunity. But the detriment is significantly less diversification.
Over the long term, REITs and real estate have a very similar return profile, but REITs have higher volatility because they're priced on a daily basis.
But volatility has nothing to do with risk when comparing REITs and direct real estate.
InvestmentNews: How is real estate positioned to handle a cycle of rising interest rates?
Mr. Halle: I would much rather be in an environment with increasing fundamentals and rising rates, versus decreasing fundamentals and lowering rates.
Over the long term, REITs have proven to be a good hedge against inflation because of an ability to raise rents in an inflationary environment.
Unlike a bond, real estate has the ability to change its income stream.
InvestmentNews: Where and how does real estate fit into most diversified portfolios?
Mr. Halle: Real estate has low correlation with the broader market, which increases return and reduces risk, and really completes an asset allocation model.
Real estate returns are based on local market fundamentals of supply and demand. In a market where you don't have new supply of real estate — and demand is growing — real estate landlords can exhibit pricing power.
The fact that real estate in New York has no correlation to office space in London or Hong Kong is one example of diversification.
InvestmentNews: What should investors know about real estate outside the United States?
Mr. Halle: In the U.S., we're accustomed to companies that have a sector focus, but outside the U.S., a lot of companies have a geographic focus. They can exhibit expertise in a market and are more diversified.
It really gives investors in the U.S. the ability to access markets that have significant diversification and exposure to different market cycles.
Typically, that has been the purview of very large institutional investors.
InvestmentNews: What sectors do you favor most right now?
Mr. Halle: I still like high-end retail malls. I think the lack of new supply, and increasing demand and specialization of companies, bring value to investors.
I also like hotels and apartments at this point in that we're in the economic expansion phase of the cycle, and short-duration leases will benefit managers as they increase rents.