REITs: Ever changing, Ever Valuable

Until recently, office buildings were the pinnacle of commercial real estate—skyscrapers stretched perception and awed as symbols of prestige and value. Malls were the buttressed center of communities, where young people reliably gathered to hang out at the video arcade and their families would do what Americans do best: consume. What happens when behaviors change? Franklin Equity Group Portfolio Managers Blair Schmicker and Daniel Scher reflect on the ever-evolving landscape of the commercial real estate, and the answer to that question might surprise you.

Digital disruption has come for real estate!

That’s the headline, right? First, e-commerce emptied brick-and-mortar retail stores and malls, and now, offices have been laid bare by technology tools that make work-from-home a durable reality. If you only read the headlines, you might expect this spells doom for commercial real estate in general, and for real estate investment trusts (REITs) in particular.

At its core, the value of real estate lies in the land, not the structure. That’s what the colloquialism “location, location, location” means. And the best, highest-value use of land is always changing. I [Blair] learned this lesson first-hand as the child of a real estate investor/developer. My father preferred the backwaters of real estate—marinas and mobile home parks—rather than shiny office buildings. But it was his discovery of a specific up-and-coming backwater in the late-1980s that turned odd parcels of unloved but well-located land into gold that built his career. What was it? Self-storage has since emerged from the backwaters to be one of the most important subsectors within the US REIT universe.

It shouldn’t be surprising to learn that the composition of the investable REIT universe has continually evolved to favor the disruptors over the disrupted. Indeed, the REIT landscape has seen significant changes over the past decade, reflecting shifts in the real estate market and investor preferences. While it’s true that malls and office space used to be the pinnacle of commercial real estate as measured by value, that’s no longer the case. The base building block of commercial real estate is land. How the economy has deployed inherently scarce land has evolved over time, and equity markets have adjusted in tandem to reflect this evolution.

In recent years, specialized technology-adjacent property types such as towers, data centers, and industrial have gained prominence in the real estate market due to changes in consumer behavior, technological advancements, and their critical role in supporting the modern economy. Cell towers, for instance, have become crucial in supporting wireless communication infrastructure with the proliferation of smartphones and wireless devices. Data centers have seen significant demand growth as the reliance on cloud computing and data storage continues to increase. Meanwhile, the industrial subsector has seen a surge in demand amid the rise of e-commerce, because fulfillment of online orders requires roughly three times the logistics footprint of traditional brick-and-mortar. Simultaneously, the value ascribed to disrupted property sectors like malls and offices has eroded considerably, reflecting the new realities of the economy.