Commercial real estate (CRE) is a unique asset class that warrants consideration by investors given the many benefits. Five of the key benefits of CRE investment are:
(1) A large investable universe,
(2) Income returns,
(3) Lower volatility,
(4) Diversification, and
(5) Inflation hedging.
Large Investable Universe
After bonds (61.9%) and stocks (28.7%), CRE is the third largest asset class in the United States representing approximately $5.1 trillion, or 9.4%, of the $54.5 trillion investable universe, as shown in Figure 1.3. Accordingly, an investor that excludes it from a portfolio is significantly narrowing the universe of potential investment opportunities.
(CRE is defined to include multifamily, office, retail, warehouse, and hotel properties.)
Investments in general produce two kinds of returns: cash yields (income returns) and value changes (capital gains or losses). In the case of CRE, income returns (generated from tenants’ rental payments) have historically accounted for more than 90% of total returns (compared with 23% in the case of stocks). Real estate’s healthy income component is attractive to investors seeking stable cash flow. Stable income is also safer during periods of financial-market stress when liquidating assets may prove problematic.
Income returns on commercial property have been particularly attractive in recent times relative to other investment alternatives. Aggressive Federal Reserve policies aimed at promoting economic recovery (close to 0% short-term interest rates and several rounds of asset purchases) have pushed cash and Treasury bond yields down to near-record lows. Although corporate bond and equity dividend yields are attractive, they still do not match those available from CRE (see Figure 1.4).
Real estate’s substantial income component helps to temper its volatility relative to asset classes that derive a higher proportion of returns from price movement. Additionally, longer rental lease terms help to mitigate the impact economic fluctuations have on rental income. CRE as an investment has historically exhibited stability similar to bonds while being much less volatile than equities, whose prices are more sensitive to systematic risk factors and overall sentiment (see Figure 1.5). This relative stability may be especially alluring in today’s uncertain financial climate.