Many institutional investors have long considered real estate, the third-largest asset class in the U.S. investment market,1 as an essential component of their portfolio allocations. We have discussed in a previous post –what the industry commonly refers to as “core” and “non-core” strategies -- and how these different investment approaches are used to meet the unique needs of different investors.
In this post, we take a closer look at the core strategy. To define core, we go directly to NCREIF, which serves the institutional investment community as the leading provider of commercial real estate performance indices and data. According to NCREIF:
“The term Diversified Core Equity style typically reflects lower risk investment strategies utilizing low leverage and generally represented by equity ownership positions in stable U.S. operating properties diversified across regions and property types.” - NCREIF2
Most experts agree that core represents a relatively conservative real estate investment strategy that has effectively served as a fundamental portfolio component of institutional investors and family offices for years. An NEPC research report on U.S. Private Core Real Estate Investing further defines core this way:
“Core real estate assets are typically well-occupied with high-quality tenants. They have staggered leases at market-rate rents, are well maintained with little deferred maintenance, and are located in high-quality, high barrier-to-entry markets.”
It is important to note that many factors determine if an investment is truly core. According to Brian DeChesare of Mergers & Acquisitions, "Core real estate is distinguished from other real estate investment strategies by 7 characteristics":
- Tenant: Generally high-quality credit-worthy tenants signed to long-term leases
- Location: Typically in major urban markets and gateway cities with high demand
- Capital Spending: Minimal capital improvements needed; properties are high quality
- Stability: Stabilized occupancy rates and rents with predictable cash flow
- Holding Period: Longer holding periods than other strategies, typically 10+ years
- Leverage: Lower leverage amounts than other strategies, usually 40% or less
- Return Source: Returns derived chiefly from income rather than capital appreciation
The Changing Nature of Core
Core real estate investments historically have consisted of office, industrial, retail and apartment assets. But the COVID-19 pandemic has had a significant impact on commercial real estate, and these property types generally considered as core assets may have some new company. According to recent commentary from Private Equity Real Estate (PEREnews.com), the lockdowns only accentuated changing trends already occurring in the industry.
Previously vital sectors like retail and office were severely impacted during the pandemic. In contrast, industrial and alternative assets like self-storage, health care, and data centers performed well and gained market share. In many cases, these property types, once considered non-core assets, now increasingly meet the definition requirements of core (low leverage, high occupancy, income-driven returns, etc.).
“The asset allocations of the managers included in the ODCE Index are often changing. As evidence, one needs to look no further than the dramatic increase in industrial and decrease in retail allocations over the last few years. And the “other” category continues to grow, reflecting how “Core” is expanding to include other asset classes.”
- Garret Zdolshek, Portfolio Manager, IDR
For investment advisors keen on seeking out emerging investment strategies for their clients, these changes in core real estate may create unique investment opportunities. Core real estate has been a well-respected strategy among institutional investors for years and remains popular today, as PERE highlights from its annual Investments Intentions Survey 4:
“In North America, 42% of investors said core was the most attractive investment strategy in 2021, the most since 2014.” - PEREnews.com
Core appears to be well-positioned for continued growth. We hope this discussion has helped your understanding of private real estate investing and the popular core strategy.
Sources & Important Disclosures:
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.