With prices in private real estate now past the bottom, but still well below peak pricing, a critical buying window is open for investors looking to add low volatility to portfolios as well as income-generation and inflation-hedging.
Global real estate total returns have been positive1 for the last two quarters and there has been an upward trend in stable, albeit modest, valuation changes.
"It is an exciting time to be a buyer of real estate deals or an investor coming back into real estate because you are setting yourself up for a strong vintage," says Gracie Coburn, Assistant Portfolio Manager and Vice President of Nuveen Global Cities Strategy at Nuveen.
In addition to attractive valuations, there are a number of key tailwinds for the coming cycle; including the high-interest rate environment which led to high borrowing costs and stifled new construction starts.
"The combination of a very muted supply window and stable demand fundamentals across many sectors is a dynamic that is going to accelerate the recovery. It takes years to deliver a real estate project from conception to actual leasing, and investors can currently enjoy that supply tailwind for years before that window closes," she says.
A trio of portfolio benefits
One of the main benefits of private real estate is diversification because it offers low volatility and a correlation to equities of just 0.052. The trade-off, however, is often liquidity.
"This is the part of private markets that gets a lot of attention for a good reason. However, there are Goldilocks-style structures out there where investors get the benefits of low volatility, and diversification through semi-liquid vehicles," says Gracie.
The other benefits of private real estate are income and appreciation. Historically, real estate has provided a robust income stream, averaging around 5.8% in the U.S. — a figure higher than equities and fixed income, which average 2.0% and 1.9%, respectively3
"When investing in core real estate, we seek high occupancy, strong mark-to-market rent opportunities, and diversification of that cash flow across every capital event. A varied rent roll helps feed a diversified cash flow and creates a defensive income stream," she says.
Income makes up about two-thirds of the total return for private real estate, so cash flow preservation is critical. Interest rates can drive cash flow erosion and therefore management of rates is key.
"There are a couple ways to tackle cash flow erosion: by keeping a low loan-to value ratio and by hedging rates through derivatives or by investing in offsetting debt with corresponding interest income. These features help to preserve strong income returns," she says.
Finally, appreciation accounts for about one-third of total returns and is driven by valuations, which in turn are influenced by transaction data. Effective asset management, including best-in-class leasing and capital expenditure management, plays a pivotal role in driving long-term appreciation
"As capital re-enters real estate in this recovery cycle that we are currently in, that is when you are really going to see more amplified appreciation component come back to the market," she says.
Sectors supported by tailwinds
The key to outperformance relative to benchmarks at a fund level can often come down to sector allocation. Nuveen has a prolific top-down research team that makes early calls and identifies nascent macroeconomic trends.
The team is currently interested in necessity retail, both in Europe and the US, due to high going-in yields, yet less competition because there is still lagging investor sentiment towards retail. This is a real mismatch with the fundamentals including low vacancy rates and the transformation of retailers who have emerged in this post ecommerce environment that have found a way to operate and work with ecommerce.
Nuveen also feels strongly about medical offices. With occupancy at an all-time high, muted supply, and the aging demographics all providing tailwinds to long-term demand that is uncorrelated to the economy.
"There is a change in consumer preference also driving this. Consumers prefer to be outside of a hospital setting and in a smaller outpatient facility with benefits both in terms of cost and for ease," she says.
The firm is bullish on the light industrial segment of the market, where there is a tight vacancy market and e-commerce benefits are continuing to fuel the sector.
Finally, senior housing, student housing, multi-family housing in Europe and in Asia-Pacific is a big focus due to limited housing stock and a chronic lack of supply.
A unique focus
As a larger manager of real estate, Nuveen is unique in its focus on smaller and more nimble acquisitions.
"Our largest conviction areas are those smaller deals with less institutional capital chasing them, but that remain slightly out of reach of high-net-worth individuals. Those deals in the $20 million to $50 million (£15 million to £39 million) range are very compelling, sellable and easy to finance," she says.
These hand-selected acquisitions add quality, better pricing control and ultimately better quality control of the actual physical real estate.
"That aggregation of a portfolio creates better outcomes compared to if investors are just putting a lot of capital to work in a less discretionary portfolio," she says.
For more information on real estate or to speak to our team, visit Nuveen.com
1MSCI Global Quarterly Property Index (Q2 2024 data as of 4 September 2024 data release); Nuveen Real Estate Research
2As of 31 Dec 2024. Sources: NCREIF Property Index; FTSE NAREIT All Equity REITS Total Return Index; S&P 500 Total Return Index; Bloomberg U.S. Agg Total Return Value Unhedged USD; ICE BofA Current 10-Year US Treasury Index.
3As of 31 Dec 2024. Source: NCREIF, 4Q24; Bloomberg, Board of Governors of the Federal Reserve System (U.S.). Time period 2000-2024
Past performance is no guarantee of future results. Investing involves risk; principal loss is possible. For professional investor use only.
