Six Reasons Institutions Build Portfolios with Private Real Estate, and Why You Should Too.

There is a reason institutions have long considered private real estate an essential part of their investment portfolios. Actually, there are several reasons, and this discussion may help you understand why this asset class appeals to pension funds, endowments, and insurance companies alike and why it may be of interest to you as well.

Six Potential Advantages of Private Real Estate:

Diversification

Private real estate is often viewed as an asset class that may help improve the diversification of a traditional stock and bond portfolio. Since it is not publicly traded like stocks and REITs, private real estate may not be as influenced by market movements, which in theory, can help reduce overall portfolio volatility. Private real estate managers seek to provide risk-adjusted returns for their investors while helping to protect against loss. A diversified portfolio that includes private real estate may help to that end.

Leverage

Most 40-Act mutual funds are generally restricted in the amount of leverage they can use to no more than 33.33% of fund assets. Private real estate funds that are not subject to the 40 Act are not subject to the same constraints, and depending on the investment strategy, can use leverage up to 90% or more. When used appropriately, higher leverage rates can potentially boost purchasing power and increase investment returns over time.

Income Stability

It should be of no surprise to any income-oriented investor that yields on investment-grade bonds have not provided meaningful income for the past several years. In fact, when the 10-year treasury hit its all-time low in July 2020, the after-inflation yield was negative. Institutional investors are often opposed to reaching for higher yields with risker fixed income instruments. That is another reason private real estate might hold a position in their portfolios. This asset class has historically proven to be a compelling alternative source of income when yields on traditional investment-grade bonds are insufficient to meet income objectives.

Enhanced Returns

Private real estate investment managers use various strategies, including core, core plus, value-add, and opportunistic to meet the specific needs of different investors. And while core is considered the most conservative approach, the other strategies provide more opportunity for capital appreciation through property enhancements and improvements in management. The higher-return characteristics of these strategies can allow institutions to take more aggressive positions in private real estate when they believe the opportunity for significant growth exists. Of course, higher expected returns come with higher risks.

Inflation Hedge

Commercial real estate properties are considered hard assets that historically have held their values well during periods of rising inflation. Most commercial real estate leases contain rent escalation clauses often tied to the Consumer Price Index (CPI), enabling owners and property managers to raise rents as their costs for goods and wages increase. There are very few other investments with a similar built-in inflation hedge, making private real estate a desirable asset for institutions seeking to hedge against inflation.

Professional Management

Institutional investors rely on experienced investment managers to apply their investment expertise consistently in the specialized areas of focus for which they have been selected. In the world of stocks and bonds, those specialties can be as nuanced as emerging market debt, structured credit or international small-cap equity. Institutional investors have access to the same depth of management experience and skill in private real estate with professional investment managers who have practiced their craft for decades.

We trust this discussion has helped you recognize why private real estate is an important asset class for so many institutional investors. If the potential benefits we have highlighted here resonate with you, know that you are not alone. Increasingly, individual accredited investors are allocating a portion of their investment portfolios to private real estate. So now is an excellent time to speak to your investment advisor and explore your options.

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Past performance is no guarantee of future results. Real estate investments involve different degrees of risk, and a client’s financial status and risk tolerance level must be considered. Leveraged investments may present additional risks to an investor.

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