In recent years, financial professionals have increasingly turned to commercial real estate (CRE) as a valuable investment to diversify and strengthen client portfolios. This shift has been driven by the desire to enhance the traditional 60/40 portfolio mix, especially after the market volatility experienced in 2022.
Advisors are recognizing the benefits of CRE, particularly in alternative real estate sectors such as self-storage, medical outpatient buildings, and student housing, as highlighted in an Urban Land Institute article earlier this year, Investors Fueling Growth in Alternative Property Sectors.
Yet despite the increasing use of alternative property sectors, many advisors remain unfamiliar with these investment strategies, which may limit portfolio exposure to these viable real estate investment strategies and impede broader adoption.
A Migration to Alternatives
The movement towards alternative investments, including real estate, is part of a broader trend that has been referred to as the Great Reallocation. This trend reflects the need to improve portfolio performance and minimize portfolio volatility by incorporating asset classes other than stocks and bonds that are not influenced by the movements of the public markets.
According to a survey by iCapital, 80 percent of financial advisors currently use alternative investments, with a growing number seeking to include these assets in client portfolios over the next 12 months.1 The potential for CRE to offer stable returns and act as a hedge against market volatility makes it an attractive option for diversification.
A Host of Investor Benefits
Commercial real estate offers several benefits that address various needs:
1. Reducing Volatility: CRE may provide a stable income stream, which can help mitigate portfolio volatility. Unlike stocks, CRE investments are less susceptible to market fluctuations, offering more predictable returns.
2. Recession-Resilient Strategies: Many alternative CRE sectors, such as medical outpatient buildings, senior housing, student housing, and manufactured housing communities, have proven resilient during economic downturns due to consistent demand drivers.
3. Inflation Hedging: Real estate typically appreciates with inflation, and rental income can adjust to rising costs, providing a natural hedge against inflation.
4. Non-Correlation: CRE’s performance often does not correlate with traditional equity and bond markets, making it a useful tool for achieving diversified growth.
5. Tax Deferral and Elimination: Investments in Delaware statutory trusts (DSTs) and other tax-advantaged real estate investment strategies offer significant tax benefits, including deferral of capital gains and potential tax elimination under certain conditions.
Primary Real Estate Investment Solutions
There are two primary real estate investment solutions to consider to effectively integrate CRE into a portfolio:
1. Tax-Advantaged Real Estate Strategies. Tax-efficient investment vehicles like DSTs and Qualified Opportunity Zone (QOZ) funds are designed to minimize tax liabilities and can play a crucial role in wealth preservation and growth. These investment vehicles may optimize returns and defer or eliminate capital gains taxes.
2. Income and Growth Real Estate Strategies. These strategies focus on properties with the potential for capital appreciation and durable cash flow. Opportunistic, value-add, and development projects fall into this category, offering higher returns but with increased risk. Both traditional and alternative real estate sectors can be utilized, providing a balanced approach to income generation and growth within a client’s portfolio.
Commercial real estate offers a broad range of strategies that can help meet investors' diverse needs. By integrating tax-advantaged and/or income and growth strategies, portfolios may experience enhanced returns, diversification, and resilience during times of economic volatility.
To learn more about how Inland can support your investment strategies, download our Product Overview Guide today and explore the range of options available to strengthen and diversify your clients’ portfolios.