An investment in commercial real estate is the purchase of a potential future income stream from property and may enhance an investment portfolio by providing competitive returns, stability, inflation hedging, and diversification. Many of the most sophisticated investors have long recognized these portfolio benefits. As a result, commercial real estate has been a significant piece of many institutional investment portfolios. In more recent years, individual investors have had access to real estate investment structures which allow access to more institutional quality properties.
Based on July 2018 data from the National Council of Real Estate Investment Fiduciaries (NCREIF), private market commercial real estate returned an average of 9.85% over the past five years. This highly competitive risk-adjusted returns was achieved in conjunction with low volatility relative to stocks and bonds.* Unlike stocks, and to some extent, bonds, an investment in real estate is often times backed by a high level of brick and mortar. Publicly registered Real Estate Investment Trusts (REITs), have regulations that mandate a minimum percentage of profits be paid out as dividends.
A key feature of some real estate investments is the significant proportion of total return accruing from rental income over the long term. This helps reduce volatility, as investments that rely more on income return tend to be less volatile than those that rely more on capital value return.* Other, more opportunistic, real estate investments provide a more significant portion of total return in the terminal value of the future cash flow, rather than the current income. Real estate is also attractive when compared with more traditional sources of income return. The asset class typically trades at a yield premium to U.S. Treasuries and is especially attractive in an environment where Treasury rates are low.
Another benefit of investing in real estate is its diversification potential. Real estate has a low (and in some cases, negative) correlation with other major asset classes.* This means the addition of real estate to a portfolio of diversified assets can lower portfolio volatility and provide a higher return per unit of risk.
The main drawback of investing in real estate is illiquidity, or the relative difficulty in converting an asset into cash. Unlike a stock or bond transaction, which can be completed in seconds, a real estate transaction can take much longer to close. One byproduct of this relative illiquidity is that commercial real estate has historically been less susceptible to the wild price swings occasionally driven by emotional buying and selling in more liquid asset classes.*
Here’s the bottom line. Commercial real estate is a distinct asset class which may enhance the risk/return profile of an investor's overall portfolio. On its own, real estate offers competitive risk-adjusted returns, stability, income, and diversification. These are some of the reason why this asset class has, for many years, been a staple of institutional investment portfolios, and why retail investors are embracing the asset class in their portfolios.