I wish Elon Musk the best of luck in colonizing Mars, but until he succeeds, it’s axiomatic that the supply of tradable real estate is fixed. In fact, in posh parts of Planet Earth—the Champs-Élysées in Paris, Manhattan’s Fifth Avenue or the Peak in Hong Kong, for example—real estate is almost inelastic, meaning that no matter how red hot the demand, increasing supply is not an option.
It’s a simplistic observation, but the supply and demand equation explains the basic appeal of real estate investing. Plus, real estate has key traits that attract alternative investment managers—inefficient pricing that can be exploited by active management, with the potential for delivering higher returns and diversifying the portfolio.
Sophisticated investors have been investing in real estate for a long time. By 2014, they were targeting an average allocation of just over 9% to various strategies like direct investments, private funds, real estate securities, real estate debt and real assets, according to a report from Cornell University’s Baker Program in Real Estate. Some allocate much more. Yale University’s endowment, led by David Swensen, who has done more to spread the gospel of alternatives than anyone, allocated 17% of its $24 billion portfolio to real estate this year.
Individuals have been slower to invest in real estate and that’s understandable. It wasn’t until the introduction of real estate investment trusts (REITs) in the 1960s and favorable tax considerations in the 1990s that made this investment class easier for individuals to access. But institutions still have advantages over individuals. Unlike you and me, Yale can absorb the ups and downs of markets better because its investment horizon is arguably infinite.
Individual investors, by contrast, have two immediate concerns: What if there’s a repeat of 2008, when real estate values swooned along with just about every other asset class except cash? Second, what happens when—not if—interest rates rise?