Keeping it real: alternative property investments in a changed world
The pandemic crisis upended many traditional notions about real estate. Suddenly, some dependable stalwarts of the kind of low-risk property investment, be it direct ownership of income producing commercial real estate or investing through Real Estate Investment Trusts (REITs) came under threat. People stopped commuting to work and going shopping; demand for high-density urban micro flats in many markets dramatically waned.
However, rather than drying up, the landscape of opportunities has simply changed. Private real-estate yields have held up remarkably well1 through the pandemic, but tapping into private real-estate opportunities presented by the crisis requires specialised expertise.
Annualised returns from U.S. equity REITs in 20202 were -15.3%, making it the worst-performing sector in the S&P500. And though investor commitments to private real-estate funds dropped about 35% during 20203, a broad “flight to quality” saw the largest funds run by the most experienced managers enjoy the most fundraising success.
According to Preqin, more than one-third of investors plan to increase their allocations in real estate in 2021, and much of that activity is already being seen in private markets in countries like the U.S., Japan, the UK and Switzerland4. Private banks are increasingly offering private real estate funds to diversify client portfolios and, Preqin forecasts5 the private real estate fund market to grow by 50 percent from 2018 levels to be worth US$1.2 trillion by 2023.
“In the U.S., we like multi-family assets because they are one of the most resilient and diverse sources of income given their defensive characteristics6,” says Yvonne Siew, Head of Real Estate Advisory & Investments, Bank of Singapore. “Commercial real estate sectors such as data centres, logistics and grade-A office assets continue to attract investors as demand for these assets remain strong due to structural trends brought about by the pandemic.7
“Despite questions surrounding the future of work with the current prevalence of remote working, there remains a need for office space. The more pertinent question to ask is: what type of office space is still relevant as an investment product in our changing world? We maintain the view that while there will be a re-evaluation of how office space is used, it will continue to remain a crucial component of business operations8 going forward. For clients who understand the non-bank lending space, we prefer the Commercial Real Estate Debt play, particularly in the mature markets such as the U.S., Europe and Australia.”
The appeal of private real estate for investors
For high-net-worth investors, private real estate investment is complementary to traditional public opportunities like REITs or ownerships of physical assets.9
Because private funds typically assemble a substantial pool of capital, they are able to invest into a diversified portfolio of high-quality properties sourced via a rigorous, structured due-diligence process that’s difficult for individual investors to perform themselves.
Data has shown10 that private real estate returns have a considerably lower correlation to stock markets than public real estate over the past two decades. This may boost some certainty of returns expected by investors. Worthwhile to note is that, based on some calculations11, private real estate funds have in the past 20 years, provided higher income and risk-adjusted returns than public REITs.
Since the global financial crisis triggered stricter regulatory oversight of financial institutions, greater numbers of HNWIs and family offices have sought the flexibility and agility of private managers, who have a greater degree of freedom to make investment decisions.
“Clients looking to invest in private property funding rounds may pay slightly higher premiums than those who choose the public route, but they invest with a clear understanding of their position,” Siew says. “Whether it’s a physical property or an instrument like an equity real-estate fund or a private vehicle, the valuation of the underlying asset is easily understood be it an analysis of market comparables, income or discounted cashflow methodologies. We find that Asia’s high-net-worth individuals (HNWI) continue to view real estate as an attractive asset class, which is not surprising, given that so many have created or grown their wealth through real estate.”
Indeed, China’s wealthy families are twice as likely as global peers to have made their millions in real estate, according to a recent report.12 Land price appreciation in Singapore—one of the most expensive cities in the world—has fuelled wealth creation for older generations.13 And in Hong Kong, more than three-quarters of HNWIs have investments in real estate.14
Be mindful of costs and capital calls
Investors contemplating adding private real estate to their portfolios need to consider multiple factors. While the regulatory framework for private fund managers means they have more flexibility and less operational constraints, and hence are able to close transactions quicker, it also exposes investors to lower levels of transparency, particularly when it comes to costs.
A high-net-worth investor needs to have a good understanding of cost structures before committing the substantial capital necessary to participate in a private real estate fund – and to appreciate that a percentage of the initial capital raised will be absorbed by fees and not invested.
Investors may commit an initial sum to become limited partners in a fund but they must also agree to provide further instalments when managers identify additional investment opportunities. These requests for funds are known as “capital calls”, and they are not optional. Investors who are unable to meet capital calls usually have to forfeit their share.
“Risk involved is dependent on timing and the type of real estate investment you are making,” Siew says. “With the exception of publicly traded instruments, liquidity is perhaps the most common concern, and a fundamental issue that investors deal with. As with all investments, the biggest risks comprise insufficient due diligence and not fully understanding exactly where your money is being invested.”
It’s important for investors to be aware of the different styles of private real estate funds, and how they fit different investment goals. More conservative investors might opt for “core” funds that invest in high-quality stabilised real estate assets and offer predictable income and low risk. Investors with a higher risk appetite may be drawn to “value-added” or “opportunistic” funds that invest in land or assets for the purpose of developing or redeveloping them for profit.
Localised expertise is critical
The changed environment of the post-pandemic real estate landscape has only added to the questions and complexities facing potential investors. Will companies permanently downsize their office footprints to accommodate increased home-working, or expand spaces to enable greater staff distancing? Will the e-commerce boom drive long-term returns in industrial and warehousing properties?
In this changing environment, finding localised expertise is vital. Bank of Singapore’s Real Estate Advisory & Investments (REAI) team has extensive network experience, and access to best-in-class investment managers who are selected through a ground-up approach comprising rigorous due diligence and direct competitive comparison.
“In all instances, we adopt a bottom up approach - that entails examining various sectors, assessing the investment opportunities that are in play and diligence on the track record of the Investment Managers” Siew says.
“For example, we recently worked on a sheer logistics portfolio spread across the U.S. and Europe which was valued at US$4.2 billion. We saw the trend of e-commerce driving this opportunity and understood the importance of logistics against that backdrop. This portfolio has since yielded strong returns and distributed income above what was underwritten by the manager. We bring that same forward-thinking approach to each opportunity in the private real estate space. Similarly, in recognition of commercial real estate debt being one of the largest fixed income investable asset in the United States, we are also the first Asian bank that worked with a top 15 Global Manager on a first mortgage core-plus Commercial Real Estate Debt fund.”
1 Knight Frank; 2 Million Acres; 3 Institutional Investor; 4 Knight Frank; 5 Preqin; 6 JLL; 7 McKinsey & Company;
8 McKinsey & Company; 9 Black Creek Group; 10 Black Creek Group; 11 Black Creek Group; 12 Bloomberg;
13 Bloomberg; 14 Funds Global Asia;
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