Pulling Back the Curtain on Real Estate Performance

Real Estate Performance

As investor interest in the real assets sector continues to increase, we thought we’d use our Backstage Pass this quarter to pull back the curtain on one specific (often beloved) sub-sector: Real estate.

But before we get to that, some level-setting on real assets more broadly. GPs appear to be responding in kind to growing LP interest: In just the last five years, the number of real assets PPMs we’ve reviewed increased by nearly 40%. Today, real assets accounts for 26% of all private markets allocations, across approximately $5T total exposure1. One reason for the interest? Real assets have demonstrated strong downside protection in recessions – due to the income/yield component, long-term contracted cash flows and generally low leverage.

Despite the recession-hedging characteristics real assets can provide (and if you’ve heard this from us once, you’ve heard it a thousand times), to us, the periodic table chart is a great illustration of the importance of prudent and thoughtful portfolio diversification in order to provide downside protection. It also helps frame up important questions around portfolio construction, and what specifically you are looking for. Do you aim for the top-performing sectors only? Or only those that have shown consistent, middle-of-the-pack performance? Or maybe you want to combine them in some fashion – nowadays you have all of those choices available to you.

Yes, you may say, we get it. We’ve heard this from you MANY times. But what lessons can we learn from sub-sector-specific periodic table?

*pulls back the curtain*

Performance by Property Type

Here, we’re looking at performance by property type within real estate, across retail, industrial, office, apartments, Hotels and the overall NCREIF Property Index (NPI). Industrial has continued its recent trend of outperformance in 2018, while retail and office have remained challenged overall. Industrial real estate has benefitted from strong GDP growth in combination with shifting consumer preferences toward e-commerce. The multifamily market has benefitted from a lack of new single-family residential supply, coupled with muted wage growth, which has created an affordability crisis, driving increased demand for rental units. Increased borrowing costs and lower tax incentives for home ownership should continue to drive demand for multi-family housing.

If we take a step back briefly and look at the bottom right portion of the chart, showing property type returns and risks over the long-term (~40 years) there are a couple of interesting observations:

• Retail and multi-family have provided the highest historical risk-adjusted returns (highest Sharpe ratio)
• Apartments, retail and industrial have historically been top-performing sectors
• Hotel and office sectors have historically underperformed, while exhibiting higher volatility

So, where to from here? Our view is that the real estate market remains healthy, with late-cycle risk indicators in check. We believe there are still supportive long-term trends for industrial, multi-family, senior housing and data center infrastructure, both in the U.S. and internationally. Operating fundamentals as a whole continue to benefit from the strength of the global economy with moderate levels of new supply and strong absorption, while debt levels and borrowing terms remain prudent.

We hope you find this interesting. For a full overview on our outlook on the real assets sector, check out A Tale of Real Assets, our inaugural Real Assets Market Overview.