Tomorrow's Real Estate Strategy Today
Representing 17% of the U.S. investment marketplace, real estate is the third largest asset class behind bonds and equities. It has been a staple of pension plan portfolios for decades, providing diversification, reduced volatility, higher returns, income and inflation protection.
But the real estate investment market has changed over the decades. A marketplace that was once built primarily on assets in four sectors – retail, office, residential and industrial – has expanded in scope. Beyond the four basic “food groups,” the new real estate investment marketplace includes fast-growing, 21st Century property sectors, such as cell phone towers and other infrastructure, data centers and e-commerce logistics facilities. It also includes health care and self-storage facilities, as well as single-family rental and manufactured homes.
Increasingly, investors are seeking to add these newer sectors to their real estate portfolios to complement the more traditional real estate types. This strategy completes the real estate allocation, equipping it to deliver more robust diversification to further boost overall portfolio returns and reduce risk.
Building the Completion Portfolio
Private real estate core funds, which historically have made up the lion’s share of most institutional real estate portfolios, offer little exposure to the assets required to build a completion real estate portfolio. Although providers of private funds are becoming more interested in newer sectors of the real estate market, these assets currently represent only about 4% of the private real estate universe.
The public real estate market, however, offers ample opportunity to gain exposure to new economy assets, which represent approximately 58% of publicly listed U.S. REITs’ equity market capitalization.
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Institutional investors in growing numbers have turned to REITs to supplement their private real estate assets and to build completion portfolios. An estimated 60% of pension, endowment and foundation real estate portfolios on an asset-weighted basis are now a blend of public and private assets.
The Public/Private Blend’s Advantages
In addition to providing efficient and economic access to all the 21st Century real estate economy offers, REITs bring other benefits to the completion portfolio. One of those is market liquidity. Many portfolio managers whose private real estate fund investments were gated during the pandemic and during the 2008 financial crisis and its aftermath experienced the challenge of being unable to rely on liquidity from those assets to help make adjustments in their portfolios. Unlike private funds, publicly listed REIT strategies can provide immediate liquidity to rebalance or put money to work quickly to seize opportunities.
REITs also provide increased control over portfolio design and implementation, enabling investors to customize their real estate portfolios and act on convictions they may have for certain property types or geographies. This allows investors to exclude some property types or specific locations, while increasing exposure to other assets that may strengthen returns.
A Track Record of Performance
Finally, REITs have a proven track record of delivering lower costs and higher total returns net of fees than any style of private real estate fund investment. The results were documented in a recent Nareit-sponsored CEM Benchmarking study of realized investment returns and costs for approximately 200 major U.S. pension funds over a 21-year period, 1998-2018.
REIT investments delivered an average annual net return of 10.2% over the study period – nearly 270 basis points higher than the 7.5% average annual net return of private real estate. Every type of private real estate, both direct and LP/GP – style funds, underperformed REIT investments. Average annual net returns for internally managed core real estate were 9.2%; returns for opportunistic and value-added funds were 8.4%; returns for core funds were 7.8%; and returns for real estate fund-of-funds were 6.3%.
The real estate investment marketplace has changed significantly in recent decades. But the changes have brought new opportunity to real estate investors, and the evolution of the REIT market has made these opportunities readily available.
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Nareit is a Employee Group member of TEXPERS. The views expressed in this article are those of the author and not necessarily Nareit nor TEXPERS.
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