How Investors Can Benefit From Real Estate

Executive Summary:

• Cadre’s asset allocation study shows that over the last 20 years adding private commercial real estate (CRE) to a portfolio lowered volatility and led to either higher risk-adjusted returns or higher overall returns for a given level of risk.
• CRE may also serve as a hedge against rising inflation.
• There are many ways to allocate to CRE. We show the benefits of three common approaches, including adding CRE to a balanced portfolio, de-risking equities through the addition of CRE, or allocating from fixed income as a yield alternative.

Low interest rates and high equity valuations in the U.S. are steering more investors to alternative investments. Private commercial real estate (CRE, “real estate”), in particular, can be an attractive addition to a larger portfolio, potentially offering stable income streams, diversification benefits and reduced volatility. CRE may also serve as an effective hedge against rising inflation.

Cadre examined the independent risk and return characteristics of U.S. stocks (S&P 500 Index), bonds (Bloomberg Barclays US Aggregate Index) and private real estate (NCREIF Property Index) over the 20-year period ending September 30, 2021 in our recent asset allocation study. We also examined the benefits of including real estate in varying proportions with stocks and bonds. We included a 60/40 balanced portfolio consisting of 60% stocks and 40% bonds, and a blended portfolio consisting of 50% stocks, 30% bonds, and 20% private real estate.
The graph below showcases the results of this study. The most attractive location for an asset class to fall on this chart is the upper left corner, which represents higher return with lower risk. As you can see below, adding private real estate to a traditional portfolio would have helped investors achieve a more stable risk/return profile over time, while also providing real income that historically outpaced inflation.

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Notably, in this study, investments in private real estate produced a relatively stable income stream throughout both the Tech Bubble and COVID-19 market downturns, even when the market value of the property temporarily decreased.

Despite the benefits, some investors may be hesitant to make the jump to private real estate since it is considered a less liquid asset class than stocks or bonds. The time frame for CRE investing does typically run longer than traditional investments. Cadre also offers investors the opportunity to seek to enter or exit deals further along the investment lifecycle through the Cadre Secondary Market.

Diversification

To maximize the benefits of diversifying a portfolio, investors should look for low correlation between assets. Private real estate’s correlation to equities and fixed income instruments has historically been quite low (or negative). As shown in our asset allocation study, over the last 20 years, adding real estate to a portfolio lowered volatility and led to either higher risk-adjusted returns or higher overall returns for a given level of risk.

Including private real estate in a traditional stock/bond portfolio may also offer additional peace of mind when stocks or bonds undergo a correction or endure a bear market, thereby resulting in stronger performance as investors are less inclined to sell assets at an inopportune time.  

Reduced Volatility

Investments in private real estate may be able to help provide investors with more consistent returns over time. As a “real” asset, the market value of commercial real estate typically moves more slowly, based on longer time frames, whereas assets that price on a daily basis like stocks and bonds may be more heavily influenced by expectations for the next 6-12 months.

Our asset allocation study shows that adding real estate to a stock and bond portfolio helped reduce portfolio volatility by roughly 15%. These results are driven by the low correlation of private real estate to traditional asset classes, along with CRE’s attractive risk/return profile versus a traditional “balanced” portfolio comprised of 60% stocks and 40% bonds.

Stable Income Streams

Commercial real estate offers investors the chance to profit from multiple sources of return:

1. Property value can increase, which is captured on sale of the property (profit income)
2. Property owners can collect payment from tenants (earned income)
   

While the time frame required for a property to run the investment full cycle can be quite long, incoming rent can serve as relatively stable income for the duration.

Property improvements on commercial real estate assets can also increase both profit and earned income collection. For example, the addition of gyms, laundry facilities, bike rooms, etc. in multifamily properties can command higher rent. Such improvements can improve the quality of life of tenants, as well as the bottom line for investors.

Inflation Hedge

Increased rent (which increases income) may be able to help private real estate owners keep pace with rising inflation, which in turn helps to preserve the purchasing power of those dollars in real terms.

Cadre’s Data Science team performed a separate Index Study from 1979 through the third quarter of 2021, which demonstrates that private real estate did quite well during periods of high inflation over the last 40+ years, in part due to increased income. Additionally, higher inflation typically occurs during times of economic growth, in which property owners can generally find tenants more easily. This is further supportive of higher asset values.

As our Index Study revealed, private real estate returns outpaced inflation by approximately 6% in all inflationary environments. Real estate investments performed particularly well during periods of the highest inflation in the U.S, which may make this asset class even more attractive in our current economic environment.

Ways to Allocate to Private Real Estate

Here we explore three different methods that investors may use to allocate to private real estate, in order to potentially achieve the benefits shown in our studies.

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Balanced Approach: We allocated 10% to CRE in our balanced portfolio by splitting the money equally between the existing stocks and bonds. This approach strikes an attractive balance between improvements in both the risk and return of the original 60/40 portfolio.

De-risking Equities: We funded an allocation exclusively from equities in this sample. This addition of CRE may be attractive to investors worried about equity valuations, or who have recently seen significant appreciation in their equity portfolio and want to reduce their overall risk without giving up their expectation for long-term returns.

Yield Alternative: We allocated to CRE from fixed income. This allocation may help investors interested in augmenting their existing bond yield or diversifying their source of income to create a potentially more stable cash flow.

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The portfolio improvements achieved from each of three sample allocations are shown below:

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In all three examples, the addition of private real estate helped to diversify the portfolio, while it reduced portfolio risk, and/or increased expected returns. Investors seeking long-term appreciation, diversified income, or decreased risk may benefit from adding a meaningful allocation to private real estate in their existing portfolio, particularly in our current economic environment.

About Cadre

Cadre’s mission is to help make real estate more accessible, transparent and affordable to a greater number of investors, while strengthening the communities they invest in. Our financial technology supplements our Investments team’s expertise and helps us to deliver the potential for groundbreaking liquidity.

Investment opportunities may be accessed through direct participation (Deal-by-Deal), via investment in the Cadre Direct Access Fund, and in the Cadre Secondary Market, which can match interested buyers with sellers who may be exiting their positions in commercial real estate.

If you are interested in investing with Cadre, please contact us at [email protected]

Appendix

Our study methodology is as follows:

• For the series labeled CPI we use the The Consumer Price Index for All Urban Consumers: All Items (CPIAUCSL) released by BLS. Data release from May 2021.
• Data is reported as monthly levels.  We calculate 12-month percent changes between observations (YoY growth).
• 12-month percent changes are then averaged across quarters in order to align with the NPI data series.

NPI

• For the series labeled NPI we use NCRIEFs Property Index.  Data collected May 2021.
• Data is reported as a series of quarterly returns.  We aggregate to yearly returns for comparison with CPI series.

Time

• Both series are compared as quarterly observations from 1Q 1979Q1 - 1Q 2021Q.

Thresholding
Thresholding of "high" "medium" "low" inflation regimes are determined via quantiles.  For observed CPI YoY changes over [1979Q1 - 2021Q1] time period:

• 33% were below 2.13% (aka low)
• - 33% were between 2.13% and 3.35% (aka medium)
• - 33% were above 3.35% (aka high)

The chart displays the average NPI and CPI YoY for periods bucketed into each of these quantiles as observed over the [1979 - 2021] period.

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