800-638-5660

Call an Investment Guidance Specialist

March 7, 2013

David Lee David Lee, manager of the Real Estate and Global Real Estate Funds.

Mention real estate, and many people think of the place they call home. In the investment world, however, the sector encompasses a broad array of commercial opportunities spanning the globe. And, as a sector, U.S. real estate has been among the top performers of the past decade.

The Wilshire U.S. Real Estate Securities Index outperformed the S&P 500 Index by a wide margin over the 10 years ended December 31, 2012, and turned in a stellar 17.55% return through the turmoil and uncertainties of the past year (see chart below). Global real estate did even better with the FTSE EPRA/NAREIT Developed Real Estate Index, returning 28.65% in 2012.

Real Estate Performance vs. S&P 500

Source: T. Rowe Price.
Past performance cannot guarantee future results.

The main drivers of performance are the lack of construction in commercial real estate coupled with steady demand against the backdrop of limited supply, says David Lee, manager of both the Real Estate and Global Real Estate Funds.

With the yield on 10-year Treasury bonds below 2% through much of 2012, it's not surprising that investors have gravitated to a segment of the market where yields have exceeded the average yield on the S&P 500 Index.

We have been living in an environment of historically low interest rates, which has resulted in a hunger for income on the part of investors, Lee says. Real estate stocks typically pay relatively high dividends, and many companies increased their dividend payouts in 2012.

Investors also have regarded real estate stocks as a hedge against inflation, along with gold and other natural resources. So far, inflation has been subdued, Lee says, but it's likely to accelerate once the economy gains more momentum.

Global Values

While the Real Estate Fund focuses primarily on U.S. real estate investment trusts, or REITs, the Global Real Estate Fund invests in real estate securities worldwide, including Europe, Hong Kong, Japan, the Pacific Rim, and South America, as well as in the U.S.

In managing these funds, Lee keeps an eye on macroeconomic influences but primarily looks for value. Globally, he's finding value in the United States and abroad—particularly in apartments, large retail malls, and local shopping venues. The U.S. accounted for 40% of Global Real Estate Fund assets as of December 31, 2012.

Lee believes that the fundamentals remain positive for real estate investors.

Supply is likely to be limited for a while since it takes time to rebuild the pipeline following an economic slowdown. Lending for new projects is tight, although refinancing loans are more available.

At the same time, demand should continue to strengthen as job creation improves, which has been the case in the United States. Even if a stronger economy in 2013 leads to rising inflation, that should be beneficial for real estate investing.

High Valuations

One caveat is that valuations for real estate stocks are near the upper limit of their historical range, Lee says. That could lead to some weakness in the event of a general stock market sell-off. Still, I would expect investors to be attracted to the recurring income stream generated by these stocks.

The big headwinds confronting the sector—and the equities market in general—remain. The sovereign debt crisis in Europe has yet to be resolved. The United States is grappling with a deficit problem. And China's economy has been slowing, although there is some evidence that it may be bottoming.

Some variables have been removed from the equation, Lee says. China is transitioning to new leadership, which is likely to do whatever it can to spur growth. The uncertainties surrounding the U.S. election are behind us. And hopefully we will have more clarity on how the federal government plans to deal with its fiscal imbalances.

Due to its concentration in the real estate industry, the Real Estate Fund's share price could be more volatile than that of a fund with a broader investment mandate. Trends perceived to be unfavorable to real estate, such as changes in the tax laws or rising interest rates, could cause a decline in share price. Because the Global Real Estate Fund can invest substantially in foreign securities, it also will be subject to the risks inherent in non-U.S. issues.

Copyright 2014, T. Rowe Price Investment Services, Inc., Distributor. All rights reserved.