Real Estate: A Core Asset Class

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Real estate is seen as a core asset class for investors due to the various characteristics which serve to position it uniquely within a broader portfolio

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1. Significant combination of yield and potential for capital appreciation;

2. Hedge against inflation;

3. Low correlation to other asset classes.

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Significant combination of yield and potential for capital appreciation

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Real estate has shown strong returns over time stemming both from its higher yield characteristics as well as capital growth associated with the underlying asset. These characteristics allow real estate to function as a unique asset class suited to a variety of investors with different needs, as well as one which performs well in a variety of economic circumstances. Real estate generally allows for better yields than fixed income with similar credit risk, making it an attractive asset class in the current low interest rate environment.

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Hedge against inflation

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Conversely, although rising interest rates may have a negative short-term impact on real estate values, the asset class serves as a longer-term hedge against inflation due to the real nature of the underlying asset. While commodities often serve as a hedge as well, the income characteristics of real estate generally make it a more attractive asset class over the long run.

 

Many issues specific to real estate serve as underpinnings for long-term real asset prices in an inflationary environment:

1. A limited amount of land;

2. Increasing prices raise replacement cost;

3. Increasing population creates more demand;

4. Possibility of building in increases indexed to inflation on rents.

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Consumer price inflation (CPI) in the U.S. was 13.5% during 1979, the worst year since 1947. Dividend income from REITs traded through the stock exchange averaged 21.2% that year, and total returns amounted to 24.4%, more than preserving for REIT investors the purchasing power that they had lost to inflation. Inflation averaged 11.6% per year during 1978-1980, the worst three-year period in six decades; again, however, publicly traded equity REITs outpaced inflation with income and total returns averaging 12.2% and 23.1% per year, respectively. The period 1974-1981 was the most inflationary eight years in the history of the Consumer Price Index at 9.3% per year, but equity REIT returns easily preserved purchasing power, with income and total returns averaging 10.2% and 16.3% per year.

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Low correlation to other asset classes

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Increased leverage and real estate's inclusion as a major in asset class in diversified private and institutional portfolios has increased its historically low correlations with other asset classes. However, real estate remains a powerful diversifier in a broad portfolio, and certain segments of the real estate market provide an even more nuanced diversification benefit from traditional portfolios.

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Variety of opportunities and methods to invest in Real Estate

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Real estate is a diverse asset class, offering differing opportunities across capital structure, development risk, geography, sector, and market (public vs. private).

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