Other Property Types
Other property types such as senior living facilities, student housing, self-storage and medical offices have also caught the attention of investors over the past decade.
Real estate is considered a cyclical sector where changes in the broader economy impact supply and demand for commercial properties. Yet within the asset class, certain subsectors are more sensitive to the economic cycle than others. Demand for office, hotel, and retail properties often follows changes in economic growth and consumer spending, while demand for multifamily, senior, and student housing is more influenced by population trends.
Investing In Private Real Estate?
There are four main types of real estate investment strategy divided by the condition of properties targeted, level of income generation, and amount of leverage used. Each has its own return, risk, and income profile.
Core strategies have lower risk but also lower return potential. They target stabilized, often fully leased, properties in major markets requiring little improvement with, somewhat counterintuitively, low use of leverage—typically up to 30% of loan-to-value. Returns from these properties are usually in the mid-to-high single digits, derived primarily from rental income rather than capital appreciation.
Core-plus strategies target similar properties but here investors assume an incremental amount of leasing risk, may perform some light renovation, and often utilize greater leverage—typically up to 50% of loan-to-value—to achieve slightly higher returns in the high single to low double digits.
Value-add strategies target properties that are not well-leased (typically with 20% or higher vacancy) and are often in need of renovation or repositioning. Returns from value-add properties are expected to be in the low-to-mid teens, coming from a mix of rental income growth and capital appreciation. Value-add strategies also utilize higher leverage than core and core-plus strategies, typically up to 65% on a loan-to-value basis.
Opportunistic strategies carry the highest risk but also target the highest returns. Often, this involves ground-up development, restructuring or a major repositioning of assets. Returns from opportunistic strategies are expected to be in the high teens, primarily derived from capital appreciation with likely little to no income generation. Opportunistic strategies typically utilize significant leverage, often in excess of 70% of loan-to-value.
Advisors can access private real estate through limited partnerships, non-traded REITs or registered funds (interval and tender-offer funds). Fortunately, in recent years there have been more quality products coming to the market, at lower minimums and with more flexibility features.
Next Steps . . .
In today’s challenging market environment, advisors need to identify alternative sources of growth and income. They also need to provide diversification relative to traditional investments, and they need to hedge the impact of inflation. Private real estate is uniquely suited to address today’s markets.
Advisors should evaluate which of their clients would benefit from an allocation to private real estate, what funds they have access to, and then revisit their process for allocating capital.
Advisors should determine each client’s goals and objectives, risk profile and time horizon. They should then determine which fund an investor is eligible to invest in based on their wealth (whether the client is a qualified purchaser, accredited investor or sub-accredited investor). Lastly, the advisor should determine the target allocation for the asset class.
Tony Davidow is founder and president of T. Davidow Consulting, LLC, and the author of Goals-Based Investing: A Visionary Framework for Wealth Management, McGraw-Hill, 2021.