Private real estate (PRE) may offer many benefits to investment advisors tasked with building and managing client portfolios. For example, using it as a “third leg” to complement a traditional stock and bond allocation may help add stability in volatile markets. This asset class may also improve portfolio diversification and provide alternative sources of income and return.
When choosing real estate investments for a clients’ portfolio, it’s essential to evaluate your options. Understanding the characteristics of the five traditional types of real estate properties and the drivers that influence how they perform will allow you to select the asset classes most suitable for helping your clients meet their goals and objectives.
Multi-family real estate primarily consists of apartment buildings. With younger generations continuing to delay home ownership in favor of living in urban areas, national multi-family occupancy rates are at 25-year highs, and rents in most major markets are above pre-pandemic levels.
Multi-family property leases tend to be shorter than leases on other property types – averaging only one to two years. Demand drivers for multi-family properties include:
- Lifestyle trends
- Household formation
- Income levels
- Job growth and unemployment
- Birth rates
- Population migration
Office properties used to conduct professional or commercial operations are one of the asset classes significantly impacted by the economic downturn in 2020. The shift to telecommuting and working from home has influenced vacancy rates that remain above norms.
Office property leases, especially trophy properties, are typically five years or less.. Primary demand drivers for office real estate include:
- Job growth
- Work-from-home trends
- GDP growth
- Unemployment rates
- Office design densification
Industrial/logistic real estate consists of large warehouse spaces designed for activities like manufacturing, logistics, and e-commerce. This sector performed well in recent years due to the significant uptick in e-commerce-related growth.
Leases for industrial and logistic properties tend to be fairly long, with some written with terms up to 10 years. Primary demand drivers for include:
- E-Commerce sales
- Trade flows
- Consumer discretionary spending
- Manufacturing and production levels
- Supply chain reconfiguration
Brick and mortar retail properties suffered the most in the pandemic as many public businesses were forced to shut down due to state and federal mandates. As the economy recovers, brick and mortar retail is expected to begin to recover; however, many properties may be repurposed for different uses.
Most retail leases average three to five years. Factors that will influence demand for retail real estate include:
- Consumer spending
- Population growth
- Demographic shifts
- Wage growth
- Savings rates
- Credit availability
5. Other Sectors
Other non-traditional properties include student housing, data centers, senior housing, and self-storage. Not only can these property types offer additional diversification, but some are also poised for growth.
Demand drivers depend on the type of property. For example, demand for hotels, retail malls, offices, and industrial properties is typically linked to GDP, while self-storage buildings, apartments, medical offices, and senior living facilities are not. Also, lease terms vary from one property type to another. Hotels, self-storage, office, apartments, and student and senior living properties tend to have shorter leases, while retail malls, industrial properties, and data centers typically have longer lease terms.
When assessing these underlying asset classes in a potential investment for your clients, it’s important to recognize how the length of the lease can influence investment performance. For example, short-term leases like multi-family which reset every year or two and office leases that reset every few years may be more sensitive to changing economic conditions.
On the other hand, your clients may receive more consistent cash flows with investments that have longer-term leases because they are locked in for a several years, often with escalation clauses.
The Bottom Line
Each of these real estate property types has different risk and return characteristics. Understanding the nuances of the asset class, such as average lease terms and demand drivers, will help you identify and determine if a real estate allocation from one of the Big Five asset classes is suitable for your clients.