The following is our latest Fund Analyst Report for T. Rowe Price Real Estate Fund TRREX . Morningstar Premium Members have access to full analyst reports such as this for more than 1,000 of the largest and best mutual funds. Not a Premium Member? Gain full access to our analyst reports and advanced tools immediately when you try Morningstar Premium free for 14 days.
T. Rowe Price has been managed since its 1997 inception by David Lee, using a strategy that's focused on the long term and thoroughly grounded in fundamentals. With the help of a small team of analysts, Lee seeks out REITs (and some real estate operating companies) that are managed well, likely to keep growing at a steady pace, and trading below the net asset value of their underlying real estate assets. He tends to hold on to favorite stocks for a long time, so turnover is very low, under 10% annually in recent years, and nine of the 10 largest holdings (as of March 31, 2016) have been in the portfolio for more than a decade.
Lee and his team pay particular attention to the real estate characteristics of the underlying assets in the stocks they own, especially location and the length of leases. The fund has long been underweight in healthcare REITs relative to their peers and the Wilshire US REIT Index, because the properties owned by those REITs are often in unattractive locations. Similarly, this fund doesn't own any data center REITs, which have been hot lately as a play on cloud computing, because they also tend to be in out-of-the-way locations. Another reason Lee doesn't like healthcare REITs is they usually have very long-term leases, which makes them more bond-like and increases their interest-rate risk; he has shied away from triple-net lease REITs for the same reason.
REITs performed well in the first half of 2016, but this fund trailed the category and the Wilshire benchmark due to its lack of exposure to hot areas such as data centers, and weak returns by apartment and office REIT holdings such as
Process Pillar: Positive | David Kathman, CFA, Ph.D. 07/10/2016 Manager David Lee uses a sensible approach that hinges on valuation and management, earning the fund a Positive score for Process. He looks for REITs that have good growth prospects and are trading at a discount to their net asset value. Lee's patience shows in the fund's five-year average 10% annual turnover, well below the category norm during that time period. Lee's conviction also stems from a focus on quality management. In addition to a cheap price tag, Lee looks for REITs run by managers with a proven track record of allocating capital. He believes that such managers can navigate their firms through a full market cycle and can be opportunistic when buying or developing properties. If the managers are delivering, Lee doesn't feel the need to exit a position. Instead he will trim or add along the way.
Location is also a driving force behind this fund's strategy. Lee likes the barriers to entry inherent in office buildings or hotels in geographically constrained major cities. When investing outside metropolitan areas he looks at population and household income data, among other data, to get a sense for the potential foot traffic in a mall or the customer base for a self-storage center. On the other hand, the fund tends to underweight areas such as data-center REITs, which derive less value from their location. Lee believes these facilities are specialized and usually poorly located, which limits their resale potential.
In some ways, this fund's portfolio is unremarkable. It tends to have prominent positions in industry bellwethers such as
The fund is also notable for what it doesn't own. Lee focuses on traditional real estate, so he shies away from owning data-center and infrastructure REITs. The fund also stands out for its longtime underweighting in healthcare REITs. Lee dislikes the long-term length of healthcare REIT leases and their specialized uses that potentially limit resale value. The fund has typically had less than 5% of its assets in healthcare REITs, versus 10% to 15% for the Wilshire Real Estate Securities Index.
Performance Pillar: Positive | David Kathman, CFA, Ph.D. 07/10/2016 This fund features an excellent long-term track record with occasional slow spots. It has gained an annualized 10.51% from its 1997 inception through June 30, 2016, the fourth-best return out of 20 funds in the real estate category during that time.
The fund has achieved this strong record by being reliably good instead of flashy, and avoiding dramatic ups and downs. In the 11 calendar years from 2005 through 2015, it beat the real estate category eight times, but 2015 was the first year it ranked in the top decile, and it only ranked in the bottom quartile once. Manager David Lee's stock-picking in the lodging, retail, and self-storage sectors has been one of the biggest drivers of performance.
The fund has performed well in bull markets for REITs, such as 2009 and 2010, but also in periods when REITs have struggled. It did trail its peers in 2007 and 2008, the two toughest years for real estate stocks in recent memory, partly because of apartment REITs that sold off as the real estate boom ended and partly because of its lack of healthcare REITs, which typically weather slowdowns well. But it landed in the top quartile in 2013 and the top decile in 2015, when REITs struggled due to fears of rising interest rates. However, it trailed its peers in the first half of 2016 as hot areas this fund doesn't own, such as data centers, led a REIT rebound.
People Pillar: Positive | David Kathman, CFA, Ph.D. 07/10/2016 David Lee is one of the real estate category's longest-serving managers, having been at the helm of this fund since its 1997 inception. Before that, he spent four years as an analyst at the firm, which he joined out of Stanford business school in 1993. Previously he was an engineer for IBM. Lee's long experience and excellent track record help earn the fund a People score of Positive.
After also running T. Rowe Price Global Real Estate TRGRX since its 2008 inception, Lee handed that fund over to analyst Nina Jones in April 2015. Lee also serves on T. Rowe's advisory committee for real asset strategies and advises on the $4.5 billion T. Rowe Price Real Assets PRAFX. He has between $100,000 and $500,000 invested in this fund, and more than $1 million in T. Rowe Price funds as a whole.
Lee is backed up by five analysts, one of whom (Ted Robson) focuses on fixed income, plus a dedicated trader and a portfolio specialist. Three of the analysts have joined the team since mid-2014, two of them replacing other analysts who left and one of them, Dan McCulley, taking over many of Jones' day-to-day coverage responsibilities once she began managing the Global Real Estate fund. (McCulley was previously an associate analyst on this fund and returned after getting an MBA at Wharton.) Key-person risk is something of a concern since there is no named comanager, but T. Rowe Price has a track record of smoothly handling manager transitions.
Parent Pillar: Positive | 11/24/2015 T. Rowe Price is an industry leader, with a strong lineup of funds across asset classes. The firm's disciplined, risk-conscious investment process has consistently produced successful results across its fund lineup, often with less volatility than peers. Many managers spend their careers at the firm, providing continuity for fund shareholders. Manager retirements are typically announced well in advance, allowing for a long transition process.
After a few unexpected departures of top managers in 2013 and 2014 and an uptick in analyst departures on the U.S. equity team, the pace of turnover has slowed. The departure of head of fixed income Mike Gitlin was a surprise, but the firm quickly filled the role with 31-year T. Rowe Price veteran Ted Wiese. Other executive changes have been handled with ease, including that of CEO James Kennedy, who will be succeeded by Bill Stromberg in 2016. Meanwhile, the firm is in a strong financial position and remains amply resourced.
T. Rowe Price has acted in fundholders' interests by closing funds with surging asset bases and avoiding trendy fund launches. Reasonable fees and a manager compensation plan focused on long-term performance are other pluses. One area of weakness is manager ownership of fund shares, which is not among the industry's best and could stand to improve.
Price Pillar: Positive | David Kathman, CFA, Ph.D. 07/10/2016 The fund has a low 0.76% annual expense ratio, which is significantly cheaper than the real estate category average and the fund's average actively managed peer. That expense ratio also falls comfortably in the specialty no-load comparison group's cheapest quintile. The fund's Advisor share class costs 0.26% more, but even that fee level is below-average for similarly distributed share classes. To its credit, T. Rowe Price has lowered the fees here more than 20% during the past decade as the fund's assets have grown.
Investors looking for passive real estate exposure can find cheaper alternatives in the index fund universe.