What are the Key Drivers of Demand for Commercial Real Estate?
With the U.S. population currently growing at approximately 1.1% per year on average, there could be up to 38 million more people by 2030 and 68 million more people by 2045.1
38 million more people is approximately 15 additional cities the size of Dallas.1
GDP & Employment Growth
GDP and employment growth create demand for places for people to work, shop and play.3
What are Current Trends in Commercial Real Estate?
Limited New Supply
Limited development financing continues to lead to reduced supply levels.
Aggregate Monthly Construction Starts4
Favorable Operating Fundamentals
Commercial real estate continues to experience positive occupancy and rent growth. 5
Increasing Institutional Allocations to Direct Commercial Real Estate
2016 average allocation: 9.9%, up 34 basis points from 2015.6
2017 average target allocation: 10.3% , up 40 basis points from 2016.6
Percentage Allocations to Direct Real Estate
Why Invest in Commercial Real Estate?
The U.S. commercial real estate market has become a meaningful and mainstream asset class — the fourth asset class in addition to stocks, bonds and cash. Investing directly in commercial real estate can potentially benefit individual investment portfolios in a number of ways.
- Commercial real estate has delivered higher income returns than other major asset classes
- More than 70% of the total returns from commercial real estate were comprised of current income
Average Annual Income Returns9
20 Years Ended December 31, 2016
Low Correlation to Other Asset Classes
- Direct commercial real estate has exhibited historically low or negative correlation to equities and bonds
- Public commercial real estate is more highly correlated to equities than direct commercial real estate
Direct Commercial Real Estate Correlation9,10
20 Years Ended December 31, 2016
Enhanced Risk-Adjusted Return Potential
- Direct commercial real estate has delivered higher returns than equities and bonds while also being at the lower end of the risk spectrum (which represents volatility) than equities and public commercial real estate, making its risk-adjusted return more favorable than these other asset classes
20 Years Ended December 31, 2016
Prospective Hedge Against Inflation
- Direct commercial real estate has historically provided overall returns that have exceeded inflation
- Rent escalation clauses in many leases and organic rental growth can provide a strong inflation hedge
20 Years Ended December 31, 2016
1 U.S. Census Bureau — Population Division, December 2014. Census.gov — U.S. and Vintage 2015 Population Estimates: Population Estimates.
2 World Population Clock, May 2017. Estimate based on 2016 census data.
3 Source: U.S. Bureau of Labor Statistics, January 2017; U.S. Bureau of Economic Analysis, January 2017; Moody’s, 2016. Employment rate is calculated as percentage change of workforce receiving a paycheck.
4 Source: CoStar Portfolio Strategy, 4Q 2016. Data represents all office, retail and industrial properties available in the CoStar database.
5 Source: Green Street Advisors Commercial Property Outlook, May 2017. Data represents the equal-weight average of apartments, industrial, mall, office and strip center properties in the Green Street Advisors database.
6 Source: 2016 Institutional Real Estate Allocations Monitor. Institutional investors often invest on substantially different terms and conditions than individual investors, which may include lower fees, expenses or leverage.
7 Source: YaleNews, Investment return of 11.5% brings Yale endowment value to $25.6 billion, September 23, 2016.
8 Source: CalPERS, Allocation & Market Value by Asset Class as of June 30, 2016; The University of Texas Investment Management Company (UTIMCO), 2016 Annual Report, Permanent University Fund and the General Endowment Fund Asset Allocation as of December 31, 2016; Dallas Police & Fire Pension System Investment Summary as of December 31, 2016; PSP Investments Asset Mix as of March 31, 2016.
9 Source: Bloomberg, NCREIF and NAREIT. Direct commercial real estate is represented by the NCREIF Open-End Diversified Core (ODCE) Index, an equal weighted, time weighted index representing a blended portfolio of institutional-quality real estate reported net of management and advisory fees (with the exception the direct commercial real estate income data shown, which is reported gross of management and advisory fees). The term core typically reflects lower risk investment strategies, utilizing low leverage and generally represented by equity ownership positions in stable U.S. operating properties. Funds are weighted equally, regardless of size. While funds used in this benchmark have characteristics that differ from non-traded REITs (including differing management fees), our management feels that the NCREIF ODCE Index is an appropriate and accepted index for the purpose of evaluating returns on investments in direct net asset value (NAV) real estate investment trusts (REITs). Equities are represented by the S&P 500 Index, an unmanaged index of the 500 largest stocks (in terms of market value), weighted by market capitalization and considered representative of the broad stock market. Bonds are represented by the Barclays Capital Aggregate Bond Index, an index of securities that are SEC-registered, taxable and dollar denominated. The index covers the U.S. investment grade fixed rate bond market, with index components for government and corporate securities, mortgage pass-through securities and asset-backed securities. Bond income return is represented by bond yield to worst of Bloomberg Barclays US Aggregate Bond Index. Public commercial real estate is represented by the FTSE NAREIT All Equity REITs Index, which is a free-float adjusted, market capitalization-weighted index of publicly traded U.S. Equity REITs. Constituents of the Index include all tax-qualified publicly traded REITs with more than 50 percent of total assets in qualifying real estate assets other than mortgages secured by real property. An investment in direct commercial real estate differs from the FTSE NAREIT All Equity REITs Index in that direct commercial real estate investments are not publicly traded U.S. Equity REITs; differs from the Barclays Capital Aggregate Bond Index in that direct commercial real estate investments are not fixed-rate debt instruments; and differs from the S&P 500 in that direct commercial real estate investments are not large-cap stocks. Cash is represented by the 90-day Treasury bill rate. Investors cannot invest in any index. Comparisons shown are for illustrative purposes only and do not represent specific investments or the performance of the non-traded REIT. Past performance does not guarantee future results. Non-traded REITs have the ability to utilize higher leverage than is allowed for the funds in the NCREIF ODCE Index, which could increase the non-traded REIT’s volatility relative to the Index. Total returns presented assume reinvestment of distributions. Direct commercial real estate return: 7.94%; risk: 6.51%. Equities return: 7.68%; risk: 16.73%. Bonds return: 5.29%; risk: 3.51%. Public commercial real estate return: 9.67%; risk: 20.44%. Sharpe Ratios — Direct commercial real estate: 0.88; Equities: 0.33; Bonds: 0.88; Public commercial real estate: 0.37. The Sharpe ratio is calculated by subtracting the risk-free rate — such as that of the 3-Month Treasury Bill — from the rate of return for a portfolio and dividing the result by the standard deviation of the portfolio returns.
10 Correlation measures how one investment performs in relation to another, with a coefficient of +1 being a perfect, positive correlation and a coefficient of -1 being a perfect, negative correlation. When two asset classes have a correlation of +1, they will both move up or down by the same amount in the same direction. Conversely, a correlation of -1 indicates that when one asset class moves up or down, the other moves in the opposite direction by the same amount. In general, asset classes with a correlation less than 0.70 or greater than -0.70 are considered to have relatively low correlation. Research indicates that direct commercial real estate has a relatively low correlation with other asset classes, and may help reduce the volatility of a stock-and-bond portfolio. The NCREIF ODCE Index is subject to less volatility because its value is based on commercial real estate properties and not subject to market pricing forces. Lower volatility could result in lower returns during certain periods of time. Although a non-traded REIT’s stock price is subject to less volatility, non-traded REIT shares may be significantly less liquid than shares of publicly traded securities, and are not immune to fluctuations, including downward fluctuations. Additionally, the value of a non-traded REIT’s underlying property holdings will fluctuate and be worth more or less than the acquisition cost when sold. Investors are advised to consider the limitations on liquidity of non-traded REIT shares when also evaluating the volatility of a non-traded REIT’s stock prices as compared to that of the stock prices of publicly traded securities.
11 Typically, if the overall returns of an asset class exceed inflation, the asset class is considered an inflation hedge. Direct commercial real estate has historically provided overall returns that have exceeded inflation. There is no guarantee, however, that a non-traded REIT can generate the overall returns needed to outpace inflation.
12 Source: NCREIF and U.S. Bureau of Labor Statistics. The Consumer Price Index (CPI) is an indicator of inflation that measures the change in the cost of a fixed basket of products and services, including housing, electricity, food and transportation. See footnote 9 for additional index information. Investors cannot invest in any index. Comparisons shown are for illustrative purposes only and do not represent specific investments.