"Historically, real estate has provided investors with attractive current income and a strong hedge against inflation."
There are many benefits to investing in private real estate. But not all investors are aware of them. Some have basic misconceptions that can easily be dispelled by their investment advisors, experts say.
“We find that some clients of advisors feel that if they own a home, or some rental properties, or have investments in real estate investment trusts (REITs), that’s all the exposure they need to real estate,” says Chance Edstrom, West Coast Regional Director, Intermediary Sales, at commercial real estate investment manager Cadre.
Such attitudes toward real estate are understandable, but belie a lack of understanding about the ways in which private commercial real estate investing, via a sophisticated investment manager, can differ significantly from other real estate holdings.
The first and obvious difference between owning a home and owning commercial real estate is that home ownership typically doesn't provide rental income. Instead, the homeowner’s personal home is an asset that requires maintenance, year after year. Rather than providing income, it costs money. The financial rewards from home ownership typically come solely from capital appreciation.
Professional Investors Choose Properties from a Wide Universe
Some individual investors own a few rental properties, but Edstrom finds that such assets are often located near their homes, or in areas they are familiar with. While such investments do provide income, they are extremely limited geographically. This is the opposite of how the most sophisticated investors operate.
Cadre, for example, scans the entire United States to identify the best opportunities. “We constantly search for different property types in different markets where we think it makes the most sense to invest,” Edstrom says. That approach led to the company’s development of the Cadre 15 [1], their top U.S. metropolitan areas with favorable demographics, economics, and a good base for future growth.
Edstrom also notes that commercial real estate investing isn’t all about apartment rental properties. Viable assets could just as easily be warehouses, offices, or life science buildings. We look for properties normal investors would not be able to access on their own. At times they can be outside the box, investments people normally might not think about,” he says.
Another drawback faced by individual real estate investors is that they often bear all of the risk themselves, independently arranging financing, renovation, leasing, etc. In addition, an investor with relatively modest means may find that all of their real estate exposure is in a single property.
Edstrom recommends investments in which investors can take multiple stakes in a variety of locations and property types across the country. “At Cadre, we provide diversification across geographies and property types with an institutional approach,” says Dan Courtney, Cadre’s East Coast Regional Director of Intermediary Sales.
Direct Real Estate Investments Beat REITs For Diversification
Another key reason for holding a portion of real estate within a portfolio is that it helps diversify risk, which lowers overall investment volatility. However, that doesn’t necessarily work for investors who buy REITs, because their value tends to move in tandem with the larger stock indices. “REITs are going to act very much like the other stocks in your portfolio,” Courtney says.
The lack of diversification benefits from investments in REITs has been widely discussed [2]. The point was particularly salient in early 2020, at the beginning of the COVID-19 pandemic. Between February 19, and March 23, 2020, the Vanguard Real Estate Index exchange-traded fund, which tracks a basket of REITs and other real estate investments, dropped more than 40%— an even greater drop than the fall in the S&P 500 Index over the same period, which lost around 34%, according to data from Yahoo [3]. After the March 23rd market bottom, both the REIT fund and the S&P 500 rallied [4]. In other words, when the market fell in 2020, publicly traded REITs provided minimal, if any, portfolio diversification. Contrast that with direct investments in real estate. “In our own studies, we’ve seen that across long periods private real estate has been less volatile than public REITs,” Courtney says.
The drawback is that direct investments aren’t as liquid as stocks, so investors may need to commit to keeping their position for years. “Five to seven years in real estate is an appropriate period for the time horizon of that investment,” he says. “Reaping those gains takes time.”
Liquidity is a challenge Cadre has also taken on. The Cadre Secondary Market matches interested buyers of commercial real estate with sellers looking to exit their positions. Yet another benefit registered investment advisors can pitch to their clients for private investments in commercial real estate.
[1] The Cadre 15 is a list of metropolitan statistical areas periodically identified by Cadre as commercial real estate markets with strong potential for risk-adjusted returns. The Cadre 15 is developed through a combination of quantitative and qualitative analysis, including predictive analytics and on-the-ground intel. Quantitative analysis involves forecasting two-year growth projections for each market and asset class based on various variables known to drive market appreciation including but not limited to population growth, employment, rent growth, new construction, and occupancy. Qualitative analysis involves a review of quantitative data by our industry experts. There is no guarantee that an investment in a Cadre 15 market will be successful.
