Public Vs Private Real Estate: A Complementary Balance
REIT investors have recently reported performance that has outpaced private real estate returns, but there is a solid argument to expect that both strategies will have a place in one’s portfolio moving ahead.
The future returns for private and public real estate appear to be higher when combined, according to Pulkit Sharma, head of alternatives investment strategy and solutions at J.P. Morgan Asset Management, who co-authored a report titled, The role of public and private strategies in real estate. The report was released by the Strategic Investment Advisory Group.
The professionally managed global real estate market has doubled in size over the last decade to $13.3 trillion. According to the J.P. Morgan team, the figure is expected to further rise.
“The near-term decline in real estate has led people to de-emphasize the asset class in favor of private credit or other things,” added Jared Gross, head of institutional portfolio strategy at J.P. Morgan Asset Management. “That may be the wrong switch if you see real estate bottoming.”
The research stated that much of the adverse repricing has already occurred, with the first wave taking place in REITs, which have typically traded slightly over NAV. During the most recent post-COVID downturn, REITs traded at a discount to NAV and have now recovered due to more rapid repricing, according to Sharma.
Sector Diversification
Sector diversification, in addition to interest rates and portfolio valuation, is a major factor influencing returns. And, as one might imagine, diversification is expanding alongside overall market expansion.
According to J.P. Morgan’s analysis, REIT holdings and closed-end private real estate fund holdings differ significantly. Industrials are the most popular sector exposures for both REITs and private funds, but their levels vary significantly. For example, REITs have an average exposure to industrial assets of 33%, compared to 13.8% for private funds.
“Another phenomenon is that sectors in the REIT space are coming into the private space,” Pulkit observed. From cold storage to life sciences, these sectors are entering the REIT space, which is typically concentrated around four core sectors — industrials, apartment, office, and retail — which account for 90% of assets.
According to the research, REITs have a 3.3% average exposure to self-storage assets, compared with an average of 7.4% for private funds. Within life sciences, REITs have an average exposure of 2%, while private funds have an average exposure of 8.6%.
On the flip side, private funds with huge pools of capital are going beyond individual assets to portfolio-level and total-entity transactions, such as outright purchasing existing REITs (including properties and operational platforms), to acquire exposure to the expanded sectors, the report noted.
Pulkit stated that all four existing student housing REITs are now private funds, demonstrating the huge portfolio swings taking place. Other sectors currently available in private real estate options include lodging/resorts, healthcare, self-storage, timberland, diversified, gaming, telecommunications, and data centers.
An Ideal Balance
Importantly, recognizing the sector exposure and liquidity differences between both fund types, J.P. Morgan said that institutional investors of all types should have both public and private real estate exposure, which can be complementary.
The liquidity of REITs and their capacity to adjust exposures in response to market conditions are advantageous for the asset class. During COVID, for example, the quick exit from office assets surpassed that of private real estate funds. Capital market challenges and rising vacancy rates have had the largest impact on office.
An ideal balance of both public and private holdings exists, the research concluded. Overall, the predicted total return on current deals is among the highest since the Great Financial Crisis, as real estate property values have fallen due to capital market pressures.
“An allocation that includes REITs and private real estate funds results in more efficient portfolios,” the researchers concluded. “Qualitative and quantitative frameworks suggest that investors could benefit from maintaining a strategic exposure to REITs, potentially up to one-third of their overall real estate allocation, with the remainder in private strategies.”
