There are more than a few worrisome trends when surveying the current commercial real estate landscape. Headlines claim America’s biggest cities are hollowing out, everyone wants to work from home, and no one will ever shop at a store in person again. These issues suggest that vast amounts of commercial property values are at risk.
But while the pandemic changed attitudes and behaviors on many fronts, many of the fundamentals that have made CRE investing appealing historically remain intact. On a recent episode of The Yield Podcast, T. Richard Litton, Jr., President of Harbor Group, a global real estate investment manager, said “low rates and an abundance of capital has many investors looking at CRE opportunities through a short-term lens.” Investors, he added, should pay attention to recent headlines, but maintain a long-term view and carefully consider the fundamentals of CRE investments when allocating capital.
Below we highlight three fundamental macro real estate “secrets” that investors might overlook when considering Commercial Real Estate during the long road back from the pandemic.
Macro real estate secret #1 – Investors continue to put money to work in CRE
With the rapid pace of economic recovery and an economy flush with consumer spending, commercial real estate continues to generate significant activity. Transaction volumes have yet to recover to pre-pandemic heights, but Iinvestors remain drawn to the yield and income potential of CRE. The asset class grew 11% in 2020 — to more than $4.1 trillion under management globally.1
As income-generating assets, commercial properties also continue to generate income and spin cash off to property owners — even during the downturn. During the depths of the pandemic, a combination of government subsidies, landlord forgiveness and lender flexibility helped tenants continue making mortgage payments, even when things looked most dire. The one-year annualized total return for commercial real estate was 2.6% at the end of the first quarter— which was low compared to pre-pandemic levels but hardly a reason to panic.2 While property valuations declined slightly, income remained a positive contributor to performance.
Macro real estate secret # 2 – Commercial financial conditions are favorable
There is no shortage of cash-seeking yield in today’s financial markets. With the Federal Reserve committed to keeping key rates near historically low levels for at least another few years, investors will likely continue to seek out alternative sources of yield. Despite the future unknowns regarding real estate, the asset class continues to generate yields that are higher, on average, than many traditional asset classes. For example, at the end of May, U.S. commercial real estate yielded 3.9%, compared to 1.7% for the U.S. 10-year Treasury and 1.4% for U.S. equities.3
Low rates, demand for alternative yield, credit arrangements, and income-generating investments continue to support CRE as the world recovers from the pandemic.
Macro real estate secret # 3 – CRE’s liquidity premium pays off
One of the primary benefits of investing in CRE is the liquidity premium investors expect to earn over other asset classes. In exchange for locking up capital for a specific period, investors generally expect higher yields versus more liquid investments such as publicly traded stocks and bonds. The illiquidity also helps keep investor emotions in check when markets become volatile. While stocks tend to swing wildly in response to headlines, CRE tends to stay more stable as investors cannot trade in and out of privately held CRE assets or funds daily. Real estate investors also tend to hang on to property for extended periods, preferring to sell when conditions improve. As a result, CRE trends tend to play out over a much longer-term cycle as compared to other asset classes, allowing for potentially smoother returns and less volatility.
CRE’s biggest secret – longevity
While the world continues to recover from the damage created by the pandemic and investors assess what it means for the long-term prospects of their portfolios, CRE continues to exhibit the pre-pandemic fundamentals that made it an attractive asset class in recent years. Low interest rates, plenty of available capital, rising transaction activity, and income stability have contributed to a longer-term positive outlook. However, there are pockets of risk as the recovery will likely continue to be uneven and affect some sectors, industries, locations, and individual properties more than others. For example, while travel trends are ticking back up this summer, it remains to be seen if hotel occupancy will recover to pre-pandemic levels anytime soon. Office space is also a significant question mark. Office vacancy rates are lower now than after 9/11 and after the Global Financial Crisis in 2008-09, although that could change in the coming years as more companies adopt flexible work arrangements.
CRE has longer cycles than stocks and bonds, as gaps between peaks and troughs are far more expansive. It remains to be seen what the long-term impact of the COVID-19 pandemic will have on CRE, and all its sub-sectors, as many of these trends will take a long time to play out. In the meantime, investors should expect to continue earning a yield premium and regular income.
Check out the recent episode of The Yield Podcast for more current market insights on CRE investing from Yieldstreet.
Please keep in mind that real estate investments, investments in Treasuries and equity investments each carry their own distinct set of risks and liquidity characteristics. You consult a financial adviser or other professional adviser for advice specific to your situation.
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