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Portfolio Manager Insights
Navigating the supply-and-demand pendulum in commercial real estate
Certain areas of the commercial REIT market are feeling the weight of oversupply, but Fidelity’s Steve Buller believes the outlook reveals a more promising picture.
- Just a few years ago, the commercial real estate market was buzzing with new development across nearly every segment, as construction cranes dotted skylines and the supply of properties surged, explains Fidelity Portfolio Manager Steve Buller. But as this pace has slowed, he has welcomed a tighter balance between supply and demand, believing a structural shift could provide a tailwind for real estate investment trusts.
- “Commercial real estate development isn’t a sprint, it’s a marathon,” says Buller, who manages Fidelity Advisor® Real Estate Fund. “The process of bringing new properties to market is a slow and deliberate one, often taking years from concept to completion.”
- In helming the sector-focused fund, Buller employs a rigorous bottom-up investment approach, selecting REITs on a stock-by-stock basis. He draws on insights from Fidelity’s dedicated real estate team as well as the firm’s broader research resources to identify reasonably valued, high-quality opportunities. His flexible strategy allows him to pivot and adapt to evolving market conditions.
- Buller notes that even in regions or property types where supply remains elevated, the overall trajectory is one of reduction. As he sees it, this tightening supply, paired with steady demand, has helped create fertile ground for real estate stocks.
- In Buller’s view, this is not always the case, however, pointing to one counterintuitive example of a market currently experiencing constrained supply. While apartments in the nation’s Sunbelt region have seen significant building activity, the properties currently leasing were planned years ago.
- Still, Buller acknowledges that new properties continue to come to market, which has been putting downward pressure on rents, given the excess amount of newly completed buildings seeking tenants.
- He goes on to underscore that this long lead time, which varies by industry, offers a unique advantage relative to other sectors of the equity market: visibility into supply trends.
- “With construction timelines extending 18 to 36 months and supported by our internal research, we have a clearer view of the supply backdrop over the coming years, enabling us to better assess where REITs may be headed,” Buller contends.
- Consequently, from his standpoint, supply within several commercial real estate categories may have already peaked, setting the stage for a more balanced market in the years to come.
- What’s more, Buller observes several factors converging to further constrain new construction, which could create a ripple effect across the industry. These include rising construction costs – stemming from restrictive immigration policies that, in turn, have led to rising labor rates – slowing the pace of development and making new projects less economically viable.
- He believes this pattern is likely to persist, as surging demand for data centers further distorts labor supply, ultimately adding to construction delays, constraining supply and potentially driving rents higher over time.
- One area of the commercial real estate market that demonstrates this shifting supply landscape, in Buller’s view, is industrial REITs. These properties, vital for logistics and warehousing, have struggled with oversupply in recent years but may now be approaching a turning point.
- With the supply/demand balance expected to improve, Buller forecasts a rise in occupancy rates for industrial REITs. He notes that this shift could have profound implications for cash flow, as higher rental rates become necessary to justify new construction – an environment in which Prologis, a major player in logistics real estate and top portfolio holding as of November 30, is well-positioned.
- “While certain areas of the REIT market may still grapple with oversupply, the broader trends point to a tightening landscape,” Buller concludes. “Staying attuned to these dynamics may present an opportunity to potentially capitalize on the sector’s resilience.”
FEATURED FUND
Fidelity Advisor Real Estate Fund (FHEIX)
Seeks above-average income and long-term capital growth, consistent with reasonable investment risk. The fund seeks to provide a yield that exceeds the composite yield of the S&P 500 Index.
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