Rick Romano of PGIM
The PGIM Global Select Real Estate Securities fund, managed by Rick Romano, has rotated its exposure towards property types providing strong inflation protection, with the self storage and residential sectors seen as clear winners.
In the past year, the manager has focused on finding REITs with exposure to companies with above inflationary pricing power, cost structures with minimal exposure to inflation and trading at a discount to private market value. For him, the self storage sector ticks all the boxes.
"The drivers of demand for self storage are not necessarily economically based. A lot of times it has to do with divorce or death, which creates movement that is not tied to an economic cycle. So that has made them perform very defensively in these types of downturns," Romano told Investment Week.
Self storage picks include trusts such as Life Storage and CubeSmart.
Another sector Romano expects to outperform during higher inflation is the residential sector, due to what he describes as "tremendous" rent growth and a reduction of part of the labour cost due to remote leasing opportunities since Covid.
"They are able to reduce some staffing at the property level, but still maintain top line revenue growth that has been really strong. And again, from a supply perspective, very limited, while there is needs based demand. People need shelter," he said.
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The Sunbelt region in the US has attracted significant investment in apartments in recent years following an exodus from large cities during the pandemic. However, Romano is now playing the "moving back to the city" theme, with rent prices in cities like New York back above 2019 levels.
Equity residential makes up about 7.7% of the fund. Most of the fund's top holdings are US-based, with over 65% of the portfolio invested in the country.
One of the tactical trades the fund made in 2021 was retail, and shopping centres in particular, as it sought to benefit from the pent up demand for consumer discretionary goods during the reopening.
In 2022, Romano has cut back some of the fund's US retail exposure to add to areas with better inflationary prospects. The fund still has exposure to UK and European retail, but with a bias towards consumer staples rather than discretionary.
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According to Romano, real estate can outperform during an inflationary environment as long as supply and demand are favouring the landlord by getting rent increases at levels well above inflation.
REIT performance has so far been weak this year, although it has held up better than equities. The FTSE EPRA/NAREIT Developed index is down 5.5% in the last three months, while the S&P 500 is down 16.5%.
"It is a bit of a disconnect for us as to why they would underperform, but what that means going forward is that we are setting up for a pretty good entry point where you can buy REITs at a discount to the private real estate market, and get the inflation protections that these companies have, some of them built directly into their leases," he said.
