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Asset allocation

Optimizing outcomes through alternatives:
Real estate

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Real estate

With yields that significantly outpace government bond yields, according to MacroBond and MSCI data, and lease terms that range from three years to 15 years, real estate can serve as an essential component of diversified income portfolios.

Real estate offers long-term growth opportunities, in addition to diversification, stable income generation and inflation hedging. This capital appreciation potential is driven by global megatrends, such as aging populations, urbanization, technological advancement, shifts in global supply chains and rapid development in certain geographies. While private real estate has produced higher risk-adjusted returns than listed REITs, there are liquidity and diversification benefits of having both in a global real estate portfolio.

Global real estate's income premium over other asset classes

Considerations for risk factor-based investing

Income stability drives diversification and performance
When considering allocations to real estate, investors often focus on diversification as the primary reason to invest in the asset class. But the diversification benefit of real estate is largely the result of the quality and security of the income stream associated with real estate investments. Commercial real estate investments benefit from contracted revenues over periods that span market cycles. Staggering leases over different time periods — similar to laddering a bond portfolio — further reduces the impact of economic cycles on income.

Global market divergence creates opportunity
Regional real estate markets reflect different levels of maturity, growth rates and stages of the real estate cycle. Performance differences across countries and regions contribute to global real estate’s ability to diversify portfolios.

Real estate market divergence: global vs. U.S. 

Rising rents provide an inflation hedge
Real estate may provide a hedge against inflation, as both rents and property values are highly correlated with rising consumer prices.

U.S. private real estate income versus inflation growth 

Megatrends are deployed at the local level 
Megatrends, such as aging populations, urbanization, technological advancement and shifts in global supply chains, can be drivers of long-term capital appreciation, in addition to income growth. While these trends are global in nature, real estate investors need to take a bottom-up, city-level view to building a diversified portfolio to capitalize on these long-term structural drivers. Without understanding how these trends and the associated risk factors are playing out at a local level, investors risk becoming overconcentrated in certain risk factors. 

Skilled asset managers have multiple ways to add value 
A real estate manager’s local relationships are essential for sourcing attractive value-add opportunities. During the hold period, managers can unlock a property’s value and generate higher rents by refurbishing or repositioning an asset.

Figure 11: Current risk assessments across real estate markets 

COVID-19 impact: Durable shifts shape long-term investment strategy

While no real estate sector or portfolio is immune from the negative effects of the COVID-19 crisis, certain sectors and strategies are better positioned and will gain over the long term. The COVID-19 crisis presents an opportunity to focus on property types, cities and tenants that are less sensitive to economic and financial cycles. Real estate investors can enhance portfolio resilience by emphasizing factors such as low leverage, high occupancy rates, long-term leases and limited near-term lease expirations.

The retail and office sectors, in particular, are being reshaped by some durable changes that could emerge from the pandemic.
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Dimitri Stathopoulos
United States

All market and economic data from Bloomberg, FactSet and Morningstar. 

The views and opinions expressed are for informational and educational purposes only as of the date of production/writing and may change without notice at any time based on numerous factors, such as market or other conditions, legal and regulatory developments, additional risks and uncertainties and may not come to pass. This material may contain “forward-looking” information that is not purely historical in nature. 

Such information may include, among other things, projections, forecasts, estimates of market returns, and proposed or expected portfolio composition. Any changes to assumptions that may have been made in preparing this material could have a material impact on the information presented herein by way of example. Past performance is no guarantee of future results. Investing involves risk; principal loss is possible. 

All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, or liability for, decisions based on such information, and it should not be relied on as such. 

A word on risk 

All investments carry a certain degree of risk, and there is no assurance that an investment will provide positive performance over any period of time. Equity investing involves risk. Investments are also subject to political, currency and regulatory risks. These risks may be magnified in emerging markets. Diversification is a technique to help reduce risk. There is no guarantee that diversification will protect against a loss of income. Investing in municipal bonds involves risks such as interest rate risk, credit risk and market risk, including the possible loss of principal. The value of the portfolio will fluctuate based on the value of the underlying securities. There are special risks associated with investments in high yield bonds, hedging activities and the potential use of leverage. In portfolios that include lower-rated municipal bonds, commonly referred to as “high yield” or “junk” bonds, which are considered to be speculative, the credit and investment risk is heightened for the portfolio. Credit ratings are subject to change. AAA, AA, A, and BBB are investment grade ratings; BB, B, CCC/CC/C and D are below-investment grade ratings. As an asset class, real assets are less developed, more illiquid, and less transparent compared to traditional asset classes. Investments will be subject to risks generally associated with the ownership of real estate-related assets and foreign investing, including changes in economic conditions, currency values, environmental risks, the cost of and ability to obtain insurance, and risks related to leasing of properties. Socially Responsible Investments are subject to Social Criteria Risk, namely the risk that because social criteria exclude securities of certain issuers for nonfinancial reasons, investors may forgo some market opportunities available to those that don’t use these criteria. Investors should be aware that alternative investments including private equity and private debt are speculative, subject to substantial risks including the risks associated with limited liquidity, the use of leverage, short sales and concentrated investments and may involve complex tax structures and investment strategies. Alternative investments may be illiquid, there may be no liquid secondary market or ready purchasers for such securities, they may not be required to provide periodic pricing or valuation information to investors, there may be delays in distributing tax information to investors, they are not subject to the same regulatory requirements as other types of pooled investment vehicles, and they may be subject to high fees and expenses, which will reduce profits. Alternative investments are not suitable for all investors and should not constitute an entire investment program. Investors may lose all or substantially all of the capital invested. The historical returns achieved by alternative asset vehicles is not a prediction of future performance or a guarantee of future results, and there can be no assurance that comparable returns will be achieved by any strategy. 

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