If your experience allocating to real estate has been less than successful, count yourself among many other advisors. While publicly-traded real estate securities like REITs, mutual funds, and ETFs offer easy access and liquidity, these investments often move in lockstep with stocks and lose their diversification benefits during periods of market stress. And the liquidity benefit clients appreciate can exacerbate portfolio volatility when markets are roiling.
If you’ve used private real estate investments, your experience might not be much better. High general partner fees, complex investment structures, no diversification to limit risk, long investment hold times, and limited transparency have generally limited this asset class to institutional investors and sophisticated family offices.
The good news is that technological advancements have enabled asset managers to solve many of the challenges of allocating to private real estate and other alternatives. As a result, new client-centric products have been introduced, including a private real estate index fund (which we will discuss later). Once-shunned alternatives are now in vogue.
Alternatives on Center Stage
Advisors are increasingly turning to alternative investments to help diversify their clients amidst the volatility and downturns in the stock and bond markets. According to a new survey by Cerulli Associates, advisors report allocating 14.5% of assets to alternative strategies and plan to increase this portion to close to one-fifth of portfolios (17.5%) in two years.
“Reducing exposure to public markets is reported by advisors as a top reason (69% report this as a goal) for using alternative investment products in 2022, while volatility dampening and downside risk protection is a close second (66%).” - Cerulli Associates
Time for a Second Look
And among the respondents’ preferred choices of alternative products, nearly half (47%) of the surveyed advisors reported using private real estate. That figure is consistent with the growing interest we see among advisors who are drawn to the many potential benefits private real estate can provide over the long-term, including:
- True portfolio diversification
- Alternative source of durable income
- Potential for attractive risk-adjusted return profile
- Inflation hedge
Notably, private real estate can benefit portfolio diversification due to its low correlation to stocks, bonds, and REITs. And a private real estate allocation can be further diversified by geography and property types that include:
- Special purpose
Satisfying your client’s different long-term investment objectives and various risk tolerances with private real estate is relatively easy, as four primary investment strategies span the private real estate risk spectrum.
Source: Accordant Investments
And certainly, top-of-mind for your clients today is inflation's impact on spending power and investment performance. Private real estate, again represented by the NFI-ODCE index, has performed well in this current inflationary environment that started in early 2021. It is important to note that ODCE performance for this period has been driven in part by an environment of low interest rates and economic stimulus, which have both ended.
Major Asset Class Performance During Current Inflationary Period
1/1/2021 through 9/30/2022
Sources: Bloomberg LP, Accordant Investments Indices: Intermediate U.S. Corporate Bonds are Barclays Intermediate Corporate Bond Total Return Index; S&P 500 is represented by the S&P 500 Index; REITs refer to public REITs and are represented by the FTSE NAREIT All Equity Index; Private real estate is represented by the NCREIF ODCE Index; Gold is represented by the Gold U.S. Dollar Spot Price Index. This represents historical patterns utilizing varying analytical data. It is not representative of a projection of any specific investment. An investor cannot invest directly in an index. Past performance is no guarantee of future results, private real estate valuations have a lag, and ODCE performance for this period has been driven in part by an environment of low interest rates and economic stimulus, which is changing.
The Emergence of a Private Real Estate Index Fund
As mentioned earlier, new technologies have enabled asset managers to create more user-friendly products in the illiquid investment arena. IDR Investment Management (IDR), a subsidiary of USAA Real Estate and a registered investment advisor with $4.3 billion in AUM, is a representative example of this trend. By developing its patented indexing process, IDR is the first asset manager to replicate and track the holdings of the NFI-ODCE index.
As a result, IDR’s institutional fund, the IDR Core Property Index Fund LLC, launched in 2018, has effectively overcome many of the historical challenges of private real estate investing, including high fees, a lack of transparency, cumbersome subscription processes, and illiquidity. Index investing in private real estate is now a reality.
To learn more about how easy it can be to allocate to private real estate, an asset class that won’t be considered an alternative forever, call us at 833.768.0622 or by email at firstname.lastname@example.org