1. Introduction
Real estate is widely viewed as a key component of a well-balanced portfolio and by one estimate, two-thirds of all global real assets lie in real estate. Notable in today’s globalised world, real estate is the most local and geographically rooted of asset classes. While investors look for opportunities around the world, land and buildings remain situated in place. Similarly, corporate headquarters move, but buildings do not. These conditions point to the tangible, physical quality of real estate that may bring lasting value to investors. Real estate holdings also fall under specific regulatory and tax regimes, which, in turn, heightens the jurisdictional significance of these investments.
Real estate is one of the most diverse asset classes and investing in it decreases liquidity and requires longer time horizons than many other asset classes. The multifaceted characteristics of real estate dictate understanding its broad contours and examining its key subclasses in detail.
Family offices invest in real estate with divergent interests and expertise. At one end of the spectrum are family offices that grew wealthy through real estate and continue to hold the majority of their assets in the sector. Family offices commonly continue to invest where their wealth originated, especially if they retain internal capacity and knowledge in the area. At the other end of the spectrum are family offices that turn to real estate to diversify their portfolios with targeted allocations. Other family offices might look to real estate for returns not available in listed equities. Families take many different paths in their approach to this asset class.
Real estate is traditionally viewed as an effective investment to balance a portfolio because its value is often not correlated to other asset classes. Real estate may provide some degree of financial stability by generating income through the rise and fall of bond and equity markets across business cycles. Real estate shares some qualities with the bond market as effectively managed property can generate steady income–a form of yield earned through lease payments–but the title holder owns a physical building, not a piece of paper issued by a bank or government. This income is distinct from the capital gain or loss accrued when the property is bought and sold. Institutional investors primarily look to this yield-generating quality when purchasing real estate. Some family offices invest in real estate with similar intent. One strength of family offices in the real estate market is the freedom to use patient capital to backstop an entrepreneurial mindset. Family offices also have the flexibility to use real estate as an investment multiplier for other activities and they may pursue different strategies to maximise gains.
As the world economy faces headwinds from inflationary pressures, interest rate hikes, Russia’s invasion of Ukraine, supply chain strains, and the lingering effects of the Covid-19 pandemic, real estate may provide promising opportunities for family offices. There are indications that family offices increased their real estate holdings over the last few years. Whether a family office has the internal capacity and expertise to identify, execute, and then manage a property portfolio internally or they join with a private equity firm or fund to invest in real estate, understanding the role of real estate in your family office’s portfolio, the investment thesis of each opportunity and the specifics of local markets are the keys to successful risk management.
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About the Authors
David Struthers
Research LeadDavid Struthers is the research and technical report writer at Simple.
Connect with David Struthers
Francois Botha
Founder & CEOFrancois believes that the next generation of family leaders need new, simple tools and trusted experts with a fresh outlook.
Connect with Francois BothaKey opportunities
- Possible hedge against inflation
- Long term yield
- Strong, value-added growth
Key risks
- Declines in the real estate market
- Headwinds in specific industries impacting commercial real estate
- Interest rate hikes
- Tax code shifts
- Lack of liquidity
“Real estate is a local, location-oriented business.”– European real estate investor
2. Understanding the asset class
Real estate is typically divided into four traditional subclasses: residential, commercial, industrial, and undeveloped land. Residential property primarily includes owner residences while multifamily dwellings owned by investors slot into the commercial category. Commercial real estate is categorised as core, core plus, value-add, and opportunistic, which describe the location, relative risk, and potential for returns of investment properties. Real estate investors and funds typically identify strategies within these categories.
Risk Spectrum Equity
CoreHigh-quality assets located in the strongest locations
Core+High-quality assets with minor upgrade requirements; leverage utilised as a tool to enhance returns
Value-addAssets requiring repositioning or redevelopment to maximise the use of the asset
OpportunisticDistressed properties and loans, ground-up development and entity-level investing
Commercial and industrial holdings may be divided further by industry and use, as these factors assert unequal pressures across a heterogeneous market. The economic strength of a particular market segment influences the amount that businesses, manufacturers, or associated logistics firms can afford to pay in their leases. The importance of drilling down on a per-industry basis increases for specialised commercial and industrial properties.
Institutional investors traditionally concentrate their holdings in the office, retail, multifamily, industrial, and hotel market segments. More recently, non-traditional property types have received increasing attention from large investors, including family offices.
Traditional
Traditional
Commercial
Industrial
Undeveloped Land
Non-Traditional
Student housing
data centres
healthcare offices
medical facilities
assisted-living communities
Real estate lines up with megatrends
Buildings are one of the primary human-created mediums through which people experience life, live and work, create and produce. This characteristic of the market segment necessitates taking a broad view of societal megatrends when considering property investments. Where is the world economy going? What will society look like in ten, twenty-five, or fifty years? How and where will people choose to live and work? Where will goods be produced, shipped, and sold? What political, economic, and social changes will most significantly impact the real estate market?
Views differ as to which trend that is identifiable today will bring the most significant changes. Smart investors are always searching for unexpected outcomes. Still, it is an important exercise to think about the future of the world in an organised manner. The six megatrends below help us examine investment opportunities over a long time horizon.
Six Megatrends Influencing the World:
- 1. Digital disruption
- 2. Climate crisis
- 3. Demographic shifts
- 4. Economic shifts
- 5. Labour shortages
- 6. Civil, civic, and equality movements
Within real estate, increased interest in non-traditional real estate assets may be due to structural changes in the economy driven by the so-called DIGITAL forces of Demographics, Infrastructure, Globalisation, Innovation, and Technology. Each of these forces fuels distinct real estate needs.
Digital forces of Demographics
Demographics
Senior living, medical offices, single-family rental homes, manufactured housing, self-storage and affordable housing
Infrastructure
Data centres, logistics and warehouse
Globalisation
Logistics, warehouses, last mile distribution and cold storage
Innovation & Technology
Life sciences, lab spaces, and medical office buildings
Location, location, location (and use)
Real estate is a heterogeneous commodity. Through large-scale trends affecting the macroeconomic climate and real estate as a whole, the asset class is largely one of locally-specific markets with property values differing greatly according to geographic location, use, and type. These factors influence property values across cities, regions, and countries, but also create highly local variances.
Let’s take the example of the office space market in an urban centre. Location and price are usually the two most important factors for businesses considering office space leases, outweighing improvements to the property. Prices are higher in desirable, often central, locations, while offices in outlying areas are price adjusted for their locations. This can lead to property owners in the most valuable locations not investing in their properties because they can already demand premium rent. It may also decrease the likelihood of new investors developing modern and optimised office space in outlying areas because the lease rates will not support it.
Another outgrowth of real estate’s tangible, geographically fixed attribute is that reasonably located property rarely loses all of its value. Outside of catastrophic urban decline or overly specialised holdings, real estate retains its value from its physical properties, unlike more purely financial assets. The more specialised the property, the higher the concept burden and risk.
The amount of local market, legal, operational, and other forms of expertise necessary for successful real estate investments, especially in alternative subclasses raises the difficulty for family offices interested in entering the global market.
3. Primary vehicles for real estate investments
The four primary ways for family offices to gain exposure to real estate are direct investments, funds, co-investments, and real estate investment trusts (REITs).
Direct investments require the highest level of expertise and capacity to identify potential investments, develop their business case, secure financing and complete the due diligence process. Direct investments also bring forward decisions about directly managing purchased properties or contracting with an outside operating company.
Real estate funds have varying structures, and lock-up periods differ, as do the types of property targeted. The “2 and 20” model is common in funds with the fund taking 2% AUM annually as a management fee and a 20% performance fee on profits, often with a hurdle rate of profit needed before it collects. Though, there has recently been downward pressure on fund fees. One key consideration for family offices without deep knowledge of real estate markets and operations is that funds can provide exposure to diversified real estate holdings curated by fund managers. However, the lack of control or, in some cases, transparency leads some institutional investors and family offices to build direct investment capacity rather than investing through funds. These downsides can be overcome by working with funds with a single mandate and possibly through gaining representation on the fund’s board.
Family offices may also have the opportunity to join with funds through co-investments. In many cases, these opportunities only become available after an initial investment in a fund. In other circumstances, co-investments may come through wealth management advisors or possibly from their private banking relationships.
REITs may either be publicly traded or privately held and their precise structure varies across legal jurisdictions. Shares in public REITs may be purchased on major exchanges like other listed equities and their value is generally correlated with broader indices. The value of privately held REITs is more directly connected to their underlying composition and typically have lock-up periods which decrease their liquidity. Funds may invest some of their capital in REITs as a risk management tool for their own direct investments.
Each investment vehicle has distinct advantages and disadvantages, which should be considered by family offices in relation to their interest in the asset class. The first-order question “why is my family office investing in real estate?” will help guide subsequent decisions about the type of property, subclass, strategy, and investment vehicle. It will help family offices decide if they are interested in scaling up their internal capacity, starting a separate company to manage their property holdings, or paying the fees of funds in exchange for a more hands-off investment.
4. Targeted allocations and strategy
A comprehensive investment strategy is the outgrowth of the primary family office mandate of preserving and growing wealth. Real estate is often a central component of family office investment strategies for reasons that Forbes Magazine recently made clear “Real estate continues to provide good risk-adjusted returns with less correlation with other asset classes.”
Three primary real estate strategies:
- Preservation of wealth
- Portfolio diversification
- Growth
Similarly, a significant majority of family offices around the world report an interest in real estate.
Family offices around the world interested in real estate
Source: Family Offices Investing in Real Estate, Fintrex 2021
The broad interest in real estate by family offices translates into portfolio allocation. UBS found that its family office survey respondents held 14% of their portfolios in real estate in 2019. This fell to 12% in their 2022 survey, with over two-thirds of respondents indicating that they would either increase or maintain their real estate allocations. The reasoning behind this is a combination of macroeconomic factors and internal family office strategy: “With inflation high, central bank liquidity flagging and interest rates rising, family offices are reviewing their strategic asset allocation. They’re reducing fixed income allocations and sacrificing liquidity for returns, as they increase investments in private equity, real estate and private debt.”
Family offices searching for yield opportunities during the long period of historically low-interest rates, that only recently began to shift, increased their focus on real estate. UBS found:
“Beyond diversification, family offices are also looking for fresh forms of yield. While it’s illiquid, real estate is the preferred replacement, according to just over a fifth (21%) of family offices. But this varies somewhat depending on regional investment cultures. In the US and Western Europe, private debt is the most popular source of unconventional yield, as loans’ relatively high floating rates and low correlations with public markets appeal in today’s market environment.”
A significant percentage of family offices with real estate allocations maintained internal capacity in this asset class. Over half of the UBS respondents keep this asset in-house.
In-house real estate capacity
Macroeconomic headwinds and real estate
Unlike other, less tangible assets, real estate has multiple paths to realising a profit. More passive strategies rely on changes in the market price brought about through often long hold periods. Material improvements can be made to properties to increase their eventual sale price. Investors can also maximise their yield through active and effective management. For some real estate investors, market fluctuations may mask unlying operational inefficiencies or losses through poor property management. Put another way, the lack of operations revenue can be overshadowed by the appreciation of an asset.
Challenging macroeconomic conditions impact the real estate subclasses unevenly. For example, inflation impacts the apartment rental market differently in regulated and unregulated markets. Supply chain pressure brings different trickle-down effects to high street retailers, online outlets, and logistics companies that, in turn, affect their profitability and ultimately their ability to make payments on their leases. Demographic trends and environmental concerns are bringing changes to the travel and hospitality industry, which necessitate adapting investing and management strategies.
One European-based real estate investor that spoke with Simple emphasised that many poor property investments were saved by the market going up during a period of market growth. “Now we’re entering a hard period!” where real estate holdings need an optimised management strategy. When real estate value reflects broad economic conditions that drive price increases, investors can make money with suboptimal strategies. They can capture market growth through their purchases and sales. Market volatility and decline heighten the need for long-term strategies and effective management.
Interest rate rises also strongly factor in. Investors rarely make full equity investments in properties, preferring to leverage their investments with loans. Low interest rates allowed property investors to meet their expected returns and maintain competitive leases. Commercial property is commonly valued by a multiple of its real or expected leases. Generally, leases are about 5% of a property’s value. Low interest rates opened the possibility for lower lease rates, maybe around 3%, but now increasing borrowing costs contribute to increases in lease rates as leveraged owners try to stay afloat.
The key metric for real estate management across all asset subclasses is calculating returns by holding the equity multiple constant. The key question to ask when considering direct real estate investments or investing through a fund is: what would be the result if the property was sold for the same price that it was bought for? The importance of optimised property management operations increases through economic turbulence.
5. ESG and real estate
The majority of family offices are increasing their commitments to creating lasting legacies by extending their traditional philanthropic activities into their investing. They may accomplish this through impact investing, drafting formal environmental, social, and governance (ESG) statements to provide guidance across the range of their affairs and deploying ESG analytic software to evaluate their portfolios. Real estate investing is one of the clearest avenues for family offices to directly impact the environment and society through their investments.
Investing for social good may include low-income housing or housing for people with special needs. Christian Super in Australia, for example, invested in Casa Capace, a specialist disability housing development. Many family offices have the resources to make similarly impactful investments.
Environmental considerations have moved to the fore for all real estate investing and are increasingly driving value in the sector. Property value is increased through the energy efficiency of buildings, especially through formal certifications. This is one of the strongest examples of the global megatrend of the climate crisis clearly influencing value-driven investment decisions. The construction industry is also incorporating ESG frameworks into its operations. Drawn together, real estate is one of the best opportunities for family offices to further align their investments with their values.
6. Conclusion
Real estate has a slow cycle, often not correlated to other asset classes and indices, which makes it an attractive asset class with distinct value propositions across its subclasses and through macroeconomic shifts. The strength of family offices in the real estate sector comes from their access to discretionary funds with more speed and agility than many institutional and private investors. Entrepreneurial-minded family offices can be flexible in looking for opportunities if they have the capital and internal capacity to move at the speed the market demands. At the end of the day, most property retains value in a way distinct from equities and other less-tangible assets. But like all investment decisions, real estate requires distinct, often extremely locally rooted knowledge.
Determining the function that your family office wants real estate to take in your portfolio from a return and asset allocation perspective is the first step. Answer the questions, “why real estate and why now?” Building internal capacity is time-consuming and expensive, even if you are able to identify hard-to-find talent. Joining family office and investor networks to learn from the real estate experiences of others, their chosen approaches and partnerships, successes and failures, will help your family office build knowledge rooted in your prefered investment locale.
