The Defined Contribution Real Estate Council (DCREC) launched a podcast series aimed at educating plan sponsors and advisers about the potential benefits and risks of using commercial real estate investments.
The first two podcasts in the series are available now and feature David Skinner, portfolio manager and head of the defined contribution practice at Prudential Real Estate Investors (also a former co-president of DCREC). According to Skinner, adding commercial real estate to a portfolio can bring improved diversification, stronger risk-adjusted returns and lower overall correlation to stocks and bonds. Skinner suggests commercial real estate also has the ability to generate income and act as a potential inflation hedge in the defined contribution (DC) plan context.
Like investing in individual stocks, bonds or mutual funds, investing directly in commercial real estate requires no small amount of financial savvy and sophistication, Skinner says. So it is likely commercial real estate investments will do the best for DC plan participants when integrated into some type of asset allocation solution.
Skinner says he often hears questions from plan sponsors and advisers to the effect of, “Why real estate and why now?” He notes that DCREC also fields questions about potential liquidity and fee issues that are important to DC plan fiduciaries.
“First off, there is an investment universe of $31 trillion dollars in commercial real estate currently,” Skinner observes, so it’s not a new or untested area of investment, despite the fact that many plan sponsors and even advisers have probably not really considered real estate in the DC context. “It’s the third largest asset class behind stocks and bonds,” he adds, “so just looking at the size and range of investment opportunities in the space both in the U.S. and globally, it’s a compelling area for investing.”
Beyond this, the last 50 years have seen major institutional market participants, including state and municipal pension plans, large corporate pension plans, union pension plans, endowments and foundations all integrate real estate investments into their portfolios—many to a significant degree of their overall holdings.
“All these institutional investors have already pushed into real estate in a big way,” Skinner says, so the DC space is actually having to catch up in this exciting area, not least because over time the risk-adjusted returns from commercial real estate investing have proven to be strong.
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Skinner notes that commercial real estate as a broad asset class has “a unique combination of investment attributes—especially from the perspective of generating income and improving diversification.”
Of course there is risk inherent in these investments—that’s a given. But over time Skinner feels “really confident about the risk-adjusted return potential that commercial real estate offers. It can help you shape your portfolio to get lower volatility and hopefully a steadier stream of returns.”
Skinner goes on to suggest the commercial real estate asset class “also fits in nicely between stocks and bonds when a sponsors or adviser is seeking alternative investments.”
“There are so many different opportunities in the space,” he continues. “As a DC investor you will be able to find investments that have stronger return potential, like stocks, perhaps in a new commercial development, or other opportunities that are more tailored to provide stable and steady income, such as contractual leases. There’s a diversity of options in the space—that’s a big part of the message we’re trying to get out there.”
Something else to note is that commercial real estate tends to move in conjunction with inflation, Skinner says.
“This is because many leases and rent contracts include periodic rate increases programmed into their initial terms, and beyond this, they will move with the market rate as inflation hits,” Skinner concludes. “Also, market values of commercial properties generally track the cost of rebuilding or replacing that property—therefore rising construction and labor costs can actually help preserve the value of the properties, and thus the portfolio. Both of these mechanisms make commercial real estate a compelling way to think about addressing inflation within an asset-allocation portfolio.”
The DCREC says new content will be added to the podcast series every month. Current content and future podcasts can be found here: http://dcrec.org/podcast.