JLL: ‘Passive’ Investment Growth Could Boost Private Real Estate Market

JLL, Chicago, said increased passive investment into public real estate investment trusts could drive a new wave of capital into private real estate markets.

The number of passive stock market funds has grown significantly in recent years. Actively managed funds employ managers to pick shares, but passive funds simply seek to replicate an index such as the S&P 500 or a real estate index. U.S. REITs have seen increased investment from passive funds; last year, passive funds held a greater share of REIT assets (51 percent) than active funds (49 percent).

JLL Managing Director of M&A and Corporate Advisory Sheheryar Hafeez noted this evolution brings “fundamental changes” to U.S. real estate capital markets. “A few years ago, passive funds were only about 20 to 30 percent of REIT investment,” he said. “As that has grown, we have seen changes in the market. Fewer active funds means fewer potential backers for an initial public offering, for example, as passive funds will only invest in REITs when they are listed. The U.S. REIT IPO market has been fairly anemic in recent years, and we have seen few billion-dollar floats.”

The greater involvement of passive funds in the U.S. REIT market will have another effect, Hafeez said: increased passive trading means REITs will perform more like the stock market than like the underlying real estate. In addition, REIT volatility has been unexpectedly high this year, he said. REITs generally see less movement than the rest of the stock market, but they have become more volatile than the wider market since the pandemic started.

Hafeez said these factors will likely push more capital into private real estate, especially as private markets offer a range of “REIT-like” options. For example, the U.S. has a number of very large core open-ended real estate funds, which offer investors exposure to core assets and some liquidity, he said.

The COVID-19-related market upheaval could also increase private equity involvement in public real estate markets. Hafeez said U.S. office REITs have been trading at a discount to net asset value for several years. “This reflects concerns about valuations, with the U.S. market having been at or near the top for some years,” he said. “Now that we have a downswing, we expect to see more opportunities for private capital to play in the public markets.”

But REITs future are not in doubt, Hafeez said. “There will always be a place for REITs,” he said. “They offer investors a strong yield compared with the wider stock market and relative security of income thanks to the underlying real estate.”