Real estate has traditionally been considered an investment for large investors due to its capital-intensive nature. In more modern fund structures, however, ownership can be broken into more digestible portions that require lower commitment sizes.
Large institutional investors – such as sovereign wealth funds, pension funds, and insurance companies – continue to underpin the real estate investor base. The low-risk, stable, income-yielding nature of real estate is a good match for these investor types, as an investment typically offers capital preservation and regular pay-outs, two key requirements. Due to the assets at their disposal, large investors can generally invest in a fund structure, co-invest with GPs, or make direct investments. This therefore allows them to take on entire portfolios of office blocks, logistics parks, and student housing.
Investors such as wealth managers and family offices also seek direct ownership of properties, although their smaller AUM means they also turn to funds – both to diversify and to access assets that would be otherwise out of reach.
From a portfolio perspective, real estate can help achieve diversification and hedge a portfolio against inflation. A real estate asset is not highly correlated to traditional assets traded on the stock markets. Here we summarize the key reasons why real estate is attractive for investors:
- Reliable income stream/dividend yield
Properties generate monthly or quarterly rental income for their owners, which provides a valuable and reliable stream of cash. This income, also known as dividend yield, usually provides 3-5% annual return to investors and is the focus of core and open-ended funds. In assessing the level of potential income, investors and managers rely on a metric known as ‘capitalization rate’ (cap rate for short).
For example, in an economic downturn, the stock market and hedge funds
may go down, but owners of office properties continue to benefit from rental income, as most tenants are locked in multi-year contracts.
Inflation is a rise in the cost of living. Housing rentals make up part of the Consumer Price Index, which is used to determine inflation. Tenancy contract rises are linked to inflation – therefore, their value rises with inflation.
Because of both qualities mentioned above, real estate acts as an effective diversification tool in an investor’s total portfolio. Investors benefit from diversification within real estate as an asset class, as it offers a wide range of strategies, property types, and geographies to choose from.