For Income and Diversification, Try Private Equity Real Estate Funds

With U.S. equity markets at historical highs and many bonds yielding very little, high-net-worth investors are looking for income sources, particularly as more investors move into retirement. Tom Hoops, Head of Business Development at Legg Mason, argues in a Wealth Management article that private equity real estate funds merit consideration. Real estate, once accessible mainly to institutional and accredited investors through direct property ownership, is now becoming available to high-net-worth individuals through private equity funds. These funds generally require a long-term commitment, though some offer monthly or quarterly liquidity.

The article cites a 9.7 percent 20-year annualized total return for real estate as of Q2 2017, based on the NCREIF Property Index. The article notes this record spans the global financial crisis and the subsequent real estate slump. Hoops lists five reasons for investing: risk-adjusted returns that typically fall between equities and fixed income; income potential, with rents that can be adjusted to keep pace with inflation; diversification, since real estate has shown low or negative correlation with stocks and bonds; deeper, more liquid markets; and supply-demand fundamentals that he describes as favorable as economic indicators improve.

Institutional investors have nearly tripled their commercial real estate allocations, from 3.7 percent in 1990 to 9.9 percent in 2016, mostly through semi-liquid, open-end core funds. The NPI's market value has grown 16 times to $525 billion, and its constituent properties now number more than 7,300, up from fewer than 1,700.

Hoops cautions that individual investors should not buy these products blindly. Assessing a fund requires detailed knowledge of its underlying properties, local market conditions, and real estate financing. He notes a large performance gap between top- and bottom-quartile managers, historically and recently, and recommends proven active managers with substantial core real estate experience across multiple market cycles. He also says the U.S. has a growing economy and the largest liquid real estate market in the world, with Europe and Asia rebounding. The article is an opinion piece from a firm executive and should be read with that perspective in mind.