At a time when many investors and investment professionals struggle to find attractive returns in a world of tissue-thin and even negative interest rates — and while wondering about the continuation of the record-long bull market in equities — an asset class long-favored by institutional investors stands out: commercial real estate. Typically underrepresented in portfolios of individual investors, commercial real estate can offer a mix of stability, income, and capital appreciation that many investors and their advisors are seeking. For a better understanding of commercial real estate and its role in portfolios, InvestmentNews Content Strategy Studio recently spoke with financial services veteran Mark M. Goldberg, Chief Executive Officer of Griffin Capital Securities.
InvestmentNews Content Strategy Studio (INCSS): Let's start with a core question that advisors and their clients might ask: Why should commercial real estate be part of an investor's portfolio?
MARK GOLDBERG: Consider the composition of the capital markets. At present, there is approximately $43 trillion in the bond market, $26 trillion invested in publicly traded equities and $17 trillion in U.S. commercial real estate (Source: World Bank, SIFMA, NAREIT, December 31, 2018). Leaving aside cash, commercial real estate accounts for almost 20% of total market assets. Most individual investors are woefully under-allocated in this asset class and represent only a fraction of the reported market capitalization (home values shouldn't be considered real estate investment). From the point of view of client portfolio construction, you should consider an allocation to commercial real estate as you would any other major asset class.
Investing in commercial real estate has lowered volatility in client portfolios. For example, the NAREIT All Equity Index Series, which tracks public real estate investment trust (REIT) shares, had a 0.68 correlation to the S&P (September 1, 2013 – August 31, 2016). In August 2016, the S&P, Dow Jones Indices and MSCI moved listed equity REITs and other listed real estate companies from the Financials Sector of their Global Industry Classification Standard (GICS®) to into its own sector. This recategorization acknowledged that traded REITs represent a distinct asset class growing in popularity and worthy of isolating its performance metrics. Not surprisingly to industry professionals, the correlation of traded REITs to the S&P has since dropped to 0.50 (September 1, 2016 to August 31, 2019). This alone provides a compelling rationale to allocate commercial real estate when building a better client portfolio.
INCSS: In the past, one of the criticisms of real estate was that it was volatile due to periods of speculative overbuilding. Has that changed?
MARK GOLDBERG: All asset classes go through cycles, but historically commercial real estate has proven to be much less volatile than equities. From January 1,1999 to December 31, 2018, privately held commercial real estate (as reported by NCREIF Property Index) has declined in value on a calendar year basis only twice. Listed REITs (as measured by NAREIT All Equity REIT Index) for the same period declined only four times. The perception of real estate boom and bust cycles may have more to do with investors confusing the fundamentals of homeownership with commercial real estate investment. These are very different. The performance of the commercial asset class over a long period of measurement speaks for itself. Indeed, as investment managers, we concern ourselves with periods of drawdown and the impact on investment outcomes. Minimizing the occurrences of drawdowns is imperative when constructing healthy investment portfolios. Diversified ownership of core commercial real estate is a great way to accomplish this goal.
INCSS: Given its importance as a diversifier and as a noncorrelated asset, why is commercial real estate not as widely held by individuals as perhaps it should be?
MARK GOLDBERG: Let me provide some historical context. Real Estate Investment Trusts (REITs) were introduced in the 1960s, but the modern REIT era began in earnest in 1990 with the creation of the market for publicly traded (REITs). Since that time, the CAGR of the market capitalization for traded REITs has been 21% versus the S&P, whose market capitalization CAGR has been approximately 9% (Source: NAREIT, December 31, 1990 - December 31, 2017). Clearly, there has been substantial growth in holding commercial real estate in portfolios, but it has been a more recent phenomenon for the mass affluent investor either through direct ownership of traded REIT stocks or through pooled vehicles like target-date funds. However, of the $17 trillion in U.S. commercial real estate investment today, only $1 trillion is traded on the public equity market.
The remaining $16 trillion has been traditionally held by institutions and HNW investors through private vehicles. In fact, as reported by NAREIT, 93% of all public pension funds invest in commercial real estate as do 81% of endowment plans and 78% of private pension plans. They hold these assets because of their return profile. However, they do so with the ability to make substantial investment amounts directly into properties or through very high minimum commitments in institutional funds. But there is a democratization of commercial real estate ownership underfoot. It is becoming easier to invest in the asset class outside the listed REIT market with lower minimums, improvements in transparency, pricing, fees, and liquidity.
INCSS: You've predicted that by 2030, retail investing in real estate will be as common as equity investing. Why?
MARK GOLDBERG: It's due to a combination of factors. First, there is a growing acknowledgment of the return profile of commercial real estate. It not only has a lower correlation to the broader markets but also reduced volatility. Over the 20-year period ending December 2018, real estate has returned, on average, just slightly under 9% per year. The income component of commercial real estate returns is over 6.51%. Over the same time period, stocks, as measured by the S&P 500, returned 5.62%, with 1.99% coming from dividends (Source: Morningstar®, NECREIF Property Index). The return profile is particularly attractive to those seeking current income and potential for growth as well as stability. This is why the asset class has been so appealing to institutions as an investment.
Secondly, the improvements to investment vehicles such as interval funds have made it possible to invest alongside institutions in core commercial real estate across the country. Today it can be done with a point and click to an investment (via Cusip number) with low minimums and daily pricing, and it can be held in a client's brokerage account like any other security. Finally, one can look no further than the megatrend of disintermediation of defined benefit plans to individual's defined contribution plans to see why almost every major real estate investment manager has turned their attention to the individual investor.
Attractive long-term returns, a higher component of stable income, lower volatility, differing correlations, ease of access, and lower cost are a powerful combination. It does not require a leap of logic to see what is coming. Individual investors, through both their non-qualified accounts and defined contribution plans, will own as much real estate as they have historically (indirectly) held through their public and private pension plans. They will be better off for that choice.
INCSS: Tell us about the different kinds of commercial real estate asset classes available to investors, and which sector you favor now.
MARK GOLDBERG: There are four major commercial real estate sectors: retail, office, industrial, and multifamily. Each has its own cycle, which is affected by differing economic drivers. Each requires unique considerations when making an allocation. For example, retail is impacted by changes in a buyer's preferences for online shopping. Within a particular segment of industrial properties, industrial real estate that is strategically located to help facilitate same-day delivery is driving a significant run-up in value. Today, a healthy growing economy with low unemployment can and does support the office market.
Population demographics and generational preferences in housing create opportunities in multifamily. Of course, the age-old adage regarding real estate should never be ignored about the importance of location, location, location. I will add to that wise advice — markets are not uniform, and real estate investment is not done well from a desktop. The important question is not which sector to favor at any given time, but which investment manager you should select. To borrow from a popular commercial on television: I don't only invest in real estate, but when I do, I always choose experience and discipline. Choose wisely, my friend.
For additional information please contact Griffin Capital Securities at 866-606-5901 or visit www.griffincapital.com.
1 Source: World Bank, SIFMA, NAREIT, December 31, 2018
2 Source: NAREIT, December 31, 1990 - December 31, 2017
3 Source: Morningstar®, NECREIF Property Index
This content is made possible by Griffin Capital Company, LLC; it is not written by and does not necessarily reflect the views of InvestmentNews' editorial staff.