To invest in publicly traded real estate or private real estate, that is the question. They don’t have to be mutually exclusive, but they do present different sides of the same coin and they come with their respective pros and cons.

The case for investing in private commercial real estate got a hearing during a recent webinar presented by the Black Creek Group, a Denver-based real estate investment management firm. It was part of the Investments and Wealth Institute’s ongoing series of webinars that focus on a specific industry theme or topic, and this particular presentation centered on how investors can use real estate to find yield. 

According to industry statistics cited by Black Creek, the $15.2 trillion commercial real estate sector was the third-largest asset class by U.S. market capitalization as of last year’s fourth quarter. It trailed publicly traded equities ($46.9 trillion) and Treasurys ($23.6 trillion).

The commercial real estate space includes multifamily, office, industrial, flex, retail and hotel properties. Many investors access this segment through publicly traded real estate investment trusts, which can be purchased as stand-alone equities or as part of mutual funds or exchange-traded funds.

Publicly traded commercial real estate provides greater liquidity and lower costs for investors, and they are valued daily. But as Black Creek pointed out, they are subject to the volatility of the public markets and can trade at prices that deviate from book value.

“Public real estate has headline risk, and that produced a drawdown of 30% during the depths of Covid in 2020,” said Ryan Strauser, senior vice president of product management at Black Creek Capital Markets, the distribution arm of Black Creek Group. “It ended the year down 9%. It’s slightly more volatile than the S&P 500 on a standard deviation basis.”

Private commercial real estate properties gained 1.6% last year, according to the National Council of Real Estate Investment Fiduciaries, or NCREIF, a data provider for the institutional real estate investment market.

And going back to 1978, Strauser noted, there were four down years for the private real estate sector (including the 2008-2009 global recession), while the S&P 500 Index experienced seven down years and the Bloomberg Barclays Aggregate Bond Index saw eight down years during that period.

“Only when you have fiscal crises, like the financial crisis of 2008-2009, does it have an impact on the property market,” Strauser said. “Garden-variety recessions don’t necessarily have an impact on private real estate.”

He added there are a couple of ways to invest in private real estate. One is via direct ownership, the other is through a net asset value, or NAV REIT. “Because they’re not publicly traded, they’ll be valued at longer intervals,” Strauser said.

Yield Drivers
As espoused by Black Creek, the advantages of private commercial real estate include lower volatility than equities, portfolio diversification through low correlation to stocks and bonds, the ability to provide an inflation hedge, and income-driven returns.

“Probably the main draw is that it’s an income-generating asset,” Strauser commented.

During the webinar, Strauser noted that private real estate has historically produced average annual income-driven returns of 5.7% versus 5.0% for public REITs, 3.4% for bonds, 2.1% for equities and 1.4% for cash. In total, more than 70% of total private real estate returns come from generated income.

Strauser explained that the four key drivers of commercial real estate are population growth, GDP growth, globalization of the economy (resulting in foreign direct investment in U.S. real estate) and the industrial e-commerce revolution that entails distribution warehouses.

He’s particularly optimistic about the e-commerce angle, which he feels is still in the early stages. “Only 15% of retail sales took place online in 2020, which was a 32% year-over-year increase,” he noted. “It’s projected to expand to 19% by 2024, and to 30% by 2030.”

Nonetheless, the Covid pandemic has impacted the commercial real estate sector. Distribution warehouses tied to e-commerce are booming, but office real estate remains in flux.

“Covid is a narrative still playing out,” Strauser said. “With vaccine deployment, we’ve seen more companies with return-to-work policies. We think after Labor Day we’ll see more companies attempting to get their employees back into the office. Tech companies are still taking real estate and signing new leases.

“With multifamily, we’ve seen an influx of people leaving big, high-tax, high-cost-of-living cities and moving to the Sunbelt,” he added. “That was accelerated during Covid. I think malls will have a tough time. They were probably the most impacted from a shutdown perspective and probably from a valuation perspective. They were struggling before Covid, and I think we’ll see [malls] replaced by grocery-centered retail and e-commerce as the main ways that people buy their goods.”

He noted that grocery-centered retail is anchored by a large grocery center, with service-oriented businesses such as hair salons and restaurants filling out the storefronts.

Regarding correlations, Strauser pointed out that over the 20-year period through 2020, private real estate had a correlation to the S&P 500 of 11 basis points, or 11%. That compares to public real estate’s higher correlation of 70 basis points, or 70%. And during the most recent 10-year period that excludes the great financial crisis, private real estate’s correlation to the S&P 500 was 22% versus the 75% correlation with public real estate.

How It’s Structured
Some investors eschew private real estate because it’s less transparent (monthly valuations versus daily valuations), is less liquid and traditionally has higher fees vis-à-vis public real estate.

“The industry changed in 2012, and the structure became much more investor friendly,” said Steve Stroker, CEO of Black Creek Capital Markets. “Many have performance-driven fee structures. The sponsor has an asset management fee, but doesn’t participate until investors earn a 5% to 6% return.”

He added that there are new fee-based classes. “I know many of the people [i.e., financial advisors] on this call would probably look at an advisory share class, taking out any of the embedded fees there and then charging their advice fee on top of that.”

In addition, Stroker said, private real estate investment minimums can be as low as $10,000 or less. Regarding liquidity, he said the standard for a lot of private real estate funds it to meet 2% of redemption requests per month, 5% per quarter and 20% per year.

Stroker added that investor redemptions—as well as purchases—of private real estate typically are at net asset value.

Furthermore, he noted that private REITs can be held at all of the big custodians, and he believes these products can help advisors differentiate their practices.

In his parting shot, Stroker offered that the less-liquid nature of private real estate is one of its virtues.

“The saying goes that it’s not market timing, but time in the market,” he said. “I think private real estate helps the time in the market because it typically trades at net asset value and never trades at a premium or discount. The whole industry proved its mettle in 2020, as private real estate had muted returns and our funds had positive results every month last year. It’s a good stabilizing force in portfolios.”