Introduction
You may have heard that real estate tends to perform well in times of economic volatility. In fact, on a risk-adjusted return basis (which we acquire by calculating the Sharpe ratio), private real estate has significantly outperformed global stocks, represented by the MSCI World, and most other private capital strategies in the past fifteen years.
That said, not all real estate investments are created equal. This article explores the recent performance of different types of private real estate assets. Continue reading to learn more about various risk/return strategies, and how today’s investors can potentially find value–even in the midst of economic uncertainty.
Recent Performance of Private Real Estate
The chart above compares risk/return by primary real estate strategy from 2008-2017–a period which encompasses the 2008 Global Financial Crisis. Note that debt and fund strategies sit on the far left side (relatively low risk), while core plus and distressed opportunities can be found at the right side of the spectrum (higher risk for potentially higher returns). Opportunistic and value-added strategies, which can also be found toward the right, had the highest AUM for this time period, at $366B and $290B respectively, in the global private fund universe as tracked by Preqin.
Of course, while past performance does not guarantee future results, we can see that over this ten-year time horizon, all of the private real estate project types listed above generated positive returns on average, with varying degrees of superior risk-adjusted returns.
About the Real Estate Risk Spectrum
At EquityMultiple, we are always on the lookout for opportunities to help our investors diversify across risk/return strategies. Learn more about each investment strategy below, and consider which one(s) may be a fit for your current portfolio:
Debt
Real estate debt can provide a relatively safe investment opportunity for investors. While there is some risk that a borrower could default, investors are often protected from this downside scenario because the loan is secured by the property.
Note on today’s lending environment: loans tend to be underwritten more conservatively than they were in 2008, likely reducing the risk of distress. EquityMultiple, for instance, performs extensive due diligence and only extends loans to select sponsors we believe have good credit history.
Core
Core investments typically consist of Class A properties that are stable and income producing. Core properties are often characterized by high occupancy rates, market rate rents, and very limited deferred maintenance.
Core real estate investors usually employ a fairly passive “buy and hold” strategy, as these assets tend to be found in Tier I or Tier II markets with strong fundamentals. These types of assets may particularly appeal to investors who seek predictable, yet fairly modest returns.
Core-Plus
Core-plus investments are similar to core investments, in that the properties are relatively stable and income-producing; however, there is likely some room for light improvements. Rather than relying solely on appreciation, investors may aim to create greater future cash-flow by increasing leasing rates or raising rents to market rate.
On that note, core-plus properties are also more likely to be Class B assets in secondary markets, resulting in both higher risk and more potential for upside than a typical core investment. See here for a recent example of an EquityMultiple core plus opportunity.
CEO Charles Clinton discusses macro trends, including emphasis on certain real estate investing strategies, as of mid-2023.
Value-Add
Value add properties, by nature, require larger improvements than core-plus investments. For instance, investors might purchase an undervalued or mismanaged asset, then implement a plan to renovate the property and improve its operations.
Introducing new landscaping, painting, and adding amenities like a pool or clubhouse can all help enhance the “curb appeal” (and potential NOI) of a property. Operators might additionally consider interior value-add improvements, such as updated cabinets, countertops, fixtures, flooring, and appliances. See here for a recent example of an EquityMultiple value-add opportunity.
Opportunistic
Opportunistics properties generally require a significant amount of work to bring in market rental rates. In the meantime, investors may not see any in-place cash flow. “Ground-up” new developments fall into this category, as do many redevelopments. These types of projects tend to be fairly complex, and it can, understandably, take years for developers to execute on their business plans.
Distressed
A distressed asset refers to a real estate investment that is priced below market value—typically due to solvency or cash flow issues on the part of the asset’s current operator, manager, or owner. During the Global Financial Crisis, for instance, some investors implemented a strategy of acquiring distressed properties, recognizing the opportunity to hold the asset(s) and potentially realize value after the recession. At the start of the pandemic, many pundits speculated there would be a similar wave of distressed opportunities coming onto the market, although in hindsight, we did not see as many as expected due to the COVID relief programs.
Given the nature of these types of investments, it’s no surprise to see where they land on the risk/return spectrum. That said, if you are not too risk-averse, it may be worth exploring when and if distressed opportunities become available.
Funds
Real estate funds provide investors with an easy way to diversify their portfolios. Rather than investing in one asset, investors have the opportunity to spread their risk across multiple properties. It’s worth noting, however, there can be a wide range of properties contained within a given fund. EquityMultiple, for example, has offered a variety of funds over the past few years, including debt funds, multifamily real estate funds, and most recently, a diversified growth-focused portfolio.
Value Add Real Estate: A closer look
The events of 2022 and 2023 — rising interest rates, recession fears, and inflation — have cast value add real estate in a new light. Pensions & Investments reports that, as of mid-2023, sovereign wealth funds are most weighted to value add real estate investing strategy among their real estate allocations. Inflation has abetted some, which makes capital improvements potentially less daunting for sponsors as they put together a pro forma. Many markets in the U.S. are experiencing affordable housing shortages. Improving and densifying older multifamily stock could be one method of meeting this challenge, and an opportunity for value add real estate investors.
While we always recommend a diversified approach, value add real estate investing could be worth a close look for any investor seeking upside.
The Bottom Line
All investments carry some level of risk. The question for investors, then, is how much risk they are comfortable taking on at any given time. With high interest rates and talk of an upcoming recession, some investors have already begun to pull out of public equities. Cash, however, is not always king. At this moment, you may want to consider diversifying into alternatives, such as private market real estate, which can help mitigate at least some volatility risk and potentially hedge against inflation.
We firmly believe in the value of portfolio diversification, and encourage you to explore options across the risk/return spectrum. For more insight, please review our Guide to Alternative Investments.
If you have any questions, please feel free to reach out to our Investor Relations Team at ir@equitymultiple.com, or schedule time to discuss your portfolio here.
