The low volatility in commercial real estate returns can be explained by the fact that in comparison to other asset classes, a high proportion of returns are being generated by income rather than capital appreciation. Notably, in comparison to residential property, commercial real estate lease term agreements are long-term in nature and are usually contracted over a 5 to 10-year time-frame. Even 15 or 20+ year leases are not uncommon. These long-term lease agreements help provide a relatively stable income stream to investors. This helps to generate a stable return pattern and reduce total return volatility.
Different ways to invest in real estate
Direct real estate
When investing in direct real estate, investors purchase the assets themselves and gain access to the ‘pure’ risk of real estate. This means they can try to achieve predictable, secure, long-term rental cash-flows through exposure to the real estate market cycle, rather than the equity market. The downside of owning a physical asset is that money has to be spent on maintaining the asset over time and liquidity can also be a risk. Historically, direct real estate has produced relatively strong returns for investors (as illustrated in figure 2).
Unlisted property funds provide an efficient way for smaller investors to get exposure to high-quality real estate assets.
Listed real estate (REITs)
Investors in listed real estate investment trusts (REITs) do not hold the title to the property, but instead own units in a fund or trust that is listed on the stock exchange. With REITs being closely linked to the performance of the general share market, REIT performance is generally more volatile (as illustrated in figure 2) than that of unlisted funds.
However, investing in REITs, particularly by taking a global approach, provides investors with a number of advantages:
- In comparison to unlisted property funds, REITs offer greater liquidity and the ability to quickly adapt to changing market fundamentals
- If the REIT invests in listed global property companies it allows investors to gain exposure to some of the best real estate assets and managers in the world.
By taking a global approach, investors can gain access to different property cycles, economic trends and interest-rate environments. It also allows investors to broadly diversify their real estate allocation by investing into real estate asset classes that are not available domestically such as multi-family (built to rent), self-storage and student housing.
As with all listed investments though there are risks to consider such as the value of the Fund’s investment potentially decreasing as a result of adverse share market movements.