Why Now May be the Perfect Time for a Strategic Real Estate Sector Allocation
Commercial real estate is a long-term strategy that presents unique opportunities during the recovery phase of the economic cycle. Recently, the real estate market experienced a period of uncertainty and downturns caused by global events, including the COVID-19 pandemic, surging inflation and rising interest rates. These headwinds have led many investors to withdraw from the asset class, seeking safer and more liquid strategies until market conditions stabilized.1 Recent indicators have started showing signs of recovery,2 presenting investors with an opportunity to enter (or re-enter) the CRE market through a thoughtful sector allocation strategy.
For nearly two years, economic volatility battered the commercial real estate market. Green Street Commercial Property Price Index® (CPPI) shows CRE pricing dropped 21.7 percent between March and May 2022. However, as of August 6, 2024, CPPI movements have continued to trend upward, increasing by 1.7 percent and is now just 20 percent below its March 2022 peak.3 This and other leading indicators suggests that certain real estate sectors may be at or near their bottom for the current economic cycle.
Historically, real estate tends to rebound quickly after periods of economic turbulence due to its fundamental role in the economy, the inherent value of physical assets, and pent-up demand for certain sectors. For example, during the Great Financial Crisis (the “GFC”) of 2007-2009, annual investment returns dropped to lows not seen in decades. However, in the years that followed, commercial real estate yielded solid returns as the market moved toward recovery. The maroon boxes in the Callan periodic table below identify the annual returns for real estate from 2004 through 2023.4
Source: Callan Institute, The Callan Periodic Table of Investment Returns, Annual Returns for Key Indices Ranked in Order of Performance (2004-2023)
Not surprisingly, the real estate market was again significantly impacted by the COVID-19 pandemic and its aftermath. Factors such as remote work, changes in consumer behavior, and general economic uncertainty led to a decline in returns in 2020 and 2022.4 However, if the real estate market has taught us anything, it’s that “history repeats itself.” And while current economic conditions are markedly different from the post-GFC economy, the fundamentals of real estate remain constant, leading us to believe that real estate has the potential to continue to provide steady returns in the coming years.
With indicators pointing to a bottom of the current real estate cycle,2 now may also be an opportune moment to employ a strategic allocation to real estate sectors whose demand is driven by demographic, life-events. By focusing on sectors driven by demographic shifts, investors may be able to capitalize on stable demand trends including the aging American population, a shift to a work from home environment, and a significant increase in e-commerce. In fact, demographic-driven real estate sectors, such as senior housing, and self-storage (to name a few) haven’t experienced the same types of losses as some traditional sectors and are likely to experience a full recovery and quicker future growth.5
Want to learn more on why now might be time to employ a sector rotation strategy? Read our recent blog “When it comes to real estate investing, not all sectors are the same."
Research shows, institutional investors have already keyed into the value that demographic-driven sectors bring to a thoughtful sector allocation. The ODCE funds chart below showcases that, in the last decade, institutional investors have allocated approximately 10 percent of their funds to alternative, or “niche” real estate6 – most of which are driven by demographic demand. And we believe that this is just the beginning of a larger shift toward real estate sectors that are significantly less tethered to economic volatility and dislocation.
This chart represents the NCREIF Fund Index - Open End Diversified Core Equity (NFI-ODCE), which is a capitalization-weighted, gross of fee, time-weighted return index of investment returns of the largest private real estate funds pursuing lower risk investment strategies utilizing low leverage and generally represented by equity ownership positions in stable U.S. operating properties diversified across regions and property types. Full details on NFI-ODCE index can be found here: https://user.ncreif.org/data-products/funds/
With signs of market recovery becoming increasingly evident, now may be the right time to consider a strategic, long-term commercial real estate strategy. We believe by capitalizing on the current favorable economic conditions, investors who embrace a well-planned approach that includes real estate sectors driven by demographic demand can position themselves to potentially achieve significant returns and the potential for capital appreciation.
2 https://assets.inland-investments.com/files/pdf/Inland-2024-MidYear-Outlook.pdf
3 https://www.greenstreet.com/insights/CPPI
4 Callan Institute, The Callan Periodic Table of Investment Returns, Annual Returns for Key Indices Ranked in Order of Performance (2004-2023)
5 JP Morgan. Guide to Alternatives. 3Q 2024. Page 36. As of August 31, 2024. https://am.jpmorgan.com/us/en/asset-management/adv/insights/market-insights/guide-to-alternatives/
6 NCREIF NPI-Plus, 2023 Q1; Data calculated from properties held in NFI-ODCE Funds. Past performance does not guarantee future results. There can be no assurance ALT REIT will be able to implement its investment strategy.
Opinions expressed reflect the current opinions of Inland Real Estate Investment Corporation as of the date appearing in the materials only and are based on Inland Investment’s opinions of the current market environment, which is subject to change. Investors, financial professionals and prospective investors should not rely solely upon the information presented when making an investment decision and should review the most recent offering materials for the applicable investment program. Certain information contained in the materials discusses general market activity, industry or sector trends, or other broad-based economic, market or political conditions and should not be construed as research or investment advice.