As time passes and the economy’s present malaise continues to drag on, investors are escalating their search for new means of generating returns. In light of inflation-induced woes, rising interest rates and sluggish economic growth, the traditional 60/40 portfolio allocation is no longer proving effective amid this new market landscape. With seemingly few sectors free of volatility, advisors are increasingly exploring alternative asset classes and their potential to withstand the turbulence plaguing traditional markets.
This pursuit of stability has led many toward the realm of private real estate. Given the myriad benefits of investing in real estate—including advantageous tax strategies, capital appreciation and comparatively consistent and stable market valuations—it’s a logical sphere for advisors to step into. However, for all of the real estate sector’s latent profitability, there are also considerable barriers to entry. Because direct ownership demands significant resources for oversight and maintenance as well as considerable diversification, it can be near impossible for individual investors without millions in investible capital to meaningfully tap into the field’s return potential.
Despite these obstacles, advisors seeking an alternatives allocation in client portfolios have an accessibility key in the form of interval funds, which are particularly attractive given the state of the markets. Interval funds provide a greater degree of flexibility than many other fund types, an essential quality in view of the economy’s mercurial shifts as of late.
Interval funds are hybrid closed-end funds that periodically offer to purchase outstanding shares from shareholders, typically on a quarterly basis. While this repurchase-centric structure is relatively new to real estate, it carries multiple advantages that could make it easier for advisors to successfully navigate the sector. One such upside is their daily pricing at net asset value (NAV) for investors to purchase. Unlike closed-end publicly traded funds, interval funds’ values aren’t beholden to exchanges and speculation by stock market traders. Because interval funds allow investors to buy and sell at the NAV—determined by the fund’s AUM divided by the number of shares issued—with no secondary market, their pricing is more reflective of the underlying real estate’s actual value than other funds bound to ever-changing trends and trading.
Although interval funds differ in structure from established investment channels like public real estate investment trusts (REITs), they carry many of the same upsides. This includes the convenience and reliability offered by ticker symbols, daily pricing, passive ownership and attractive income returns. Likewise, although this arrangement appears to offer little in the way of liquidity at an initial glance, the interval funds structure carries several advantages for investors focused on the long haul. Interval funds give fund managers the breathing room to execute strategies suited to longer holding periods; the very nature of how they’re constructed lowers the frequency of transactions and allows investors to scout potentially more lucrative long-term returns. Additionally, the periodic quality of interval funds encourages investors to maintain a long-term investment horizon and moderate hasty, emotion-driven investing behaviors, a practice that once could prove lucrative but now grows riskier by the day.
Because the interval fund structure is still relatively new, there are many misconceptions surrounding their application and what their use entails. This includes the notions that interval funds preempt any opportunity for liquidity and that indirect real estate access through this investment vehicle is inherently inferior to direct access through other means. In reality, interval funds allow for passive ownership in the truest sense without sacrificing any of the tax advantages offered by public REITs. Even a relatively small individual investment can provide an in-road to hundreds of billions of dollars in underlying real estate exposure. Besides allowing for diversification, this type of approach provides more flexibility than direct ownership, which requires high transaction costs from purchasing and selling individual properties as well as re-allocating sector and geographic exposure. Interval funds offer a compelling alternative that allows advisors to readily sell in and out of ownership positions on a timeframe they can prepare for, empowering them to adjust client portfolios appropriately as the market conditions require.
The opportunity presented by interval funds dovetails with current market considerations in real estate investing. Due to favorable long-term supply and demand trends, there is ample potential within both the industrial and residential rental sectors. As the last few years have seen an explosion in the use of online retail outlets, there’s been a corresponding drive to establish warehouse and distribution centers to meet demand. With e-commerce expected to more than double as a percentage of total retail sales over the next 20 years, investors may expect to see rising rents and property values in the near future, representing a lucrative opportunity with reliable occupancy rates in the industrial realm. On the residential front, the undersupply of apartments, single-family rentals and for-sale housing coupled with ongoing affordability issues, is expected to spur even greater demand for single-family rentals and multifamily in the years to come. These positive long-term prospects for real estate buck the otherwise uncertain projections many industries and investment areas are facing; as such, it would be prudent for advisors to take note.
The serious strains the market is placing on investors right now should be spurring serious ingenuity. While there are steep hurdles to clear in entering the real estate market, the sector’s potential yields relative to other areas ought to be driving advisors to diversify client portfolios by any means necessary. Considering the balance interval funds achieve in addressing market demands for higher income, lower drawdowns and less exposure to broader market trends while still providing periodic liquidity, they’re well-positioned to empower investors that may lack the resources and corresponding accessibility enjoyed by institutional and high-net-worth investors. As an alternative with lower minimum investment requirements, transparent and consistently priced NAVs, and decidedly less volatility involved, interval funds are a no-brainer real estate investment vehicle.
Miguel Sosa is a research strategist at Bluerock.