The big question for investors now is where to be invested going forward. With the overall market trading at 20x earnings and first half gains concentrated into only a select few stocks, most of the market has been left behind. With the valuations of the high-fliers now in excessive territory, the rest of the market looks much more attractive. Value stocks and cyclicals such as financials, energy, materials and consumer staples are a relative bargain and beginning to see some traction. We have maintained value exposure in all of our strategies, seeing better risk/reward near-term than in large growth. Yet the best longer-term risk/reward is in areas not much investor attention has been paid to in several years.
We see potential in sectors and industries left behind in this tech-centric advance. The relative weaker performance of small cap companies to large caps appears to have begun unwinding. We have meaningfully added to small caps in recent months. Today, foreign markets are most attractive as they are generally at lower P/E ratios, and with virtually all regions (except Europe and Japan) growing faster, they offer better value. Plus, when the Fed stops hiking rates, the U.S. Dollar should weaken relative to foreign currencies, which enhances foreign markets’ performance in dollar terms.
We stay focused on what we can control and seek the best longer-term opportunities for growth. The impact and mistakes made during and after the pandemic continue working themselves out. This is a perfect example of the cyclical dangers we work to avoid with our time-appropriate strategies. For our clients with current income needs, we maintain a sufficient level of conservative assets to withstand periods of market weakness until the tide ultimately turns higher. With shorter-term needs funded, longer-term capital can remain invested for growth, and fund future goals. This is part of each client’s personalized investment structure. We like to tell our clients to go live and enjoy life, because we’ve got their backs!
Article 5 of 5: Real Estate As An Investment Option
This is the final installment in a series of five blogs on how Owning Real Estate Complements Stock Risks. The series addresses the attributes and differentiating factors of real estate that pair nicely with traded stocks. The third & fourth segments review public real estate securities and the advantages of private real estate offerings.
Our previous blog in this series outlined the Advantages of Owning Private Real Estate. In summary, investors in private offerings will likely capture higher yields, realize less volatility, and have greater diversification benefits than public securities.
Private real estate can be accessed through a variety of investment vehicles. Below we discuss four categories.
Interval Funds are structured to trade like mutual funds but with limited liquidity. They are typically a “fund-of-funds”, meaning they invest in other real estate funds – large institutional funds that an individual investor would otherwise be unable to access. Interval funds keep some public stock and debt in their portfolio for liquidity. Since the underlying institutional funds have limited liquidity, interval funds also impose redemption limits. Typically, investors can only redeem 5% of the fund’s value per quarter. The interval fund may also have a one-year hold required to avoid a short-term redemption fee.
NAV REITS are perpetual-life REITs that directly own properties. NAV stands for net asset value, which is the value of the REIT’s assets minus its liabilities. These REITs are named for the way that their shares are priced, at their NAV per share rather than a price determined by trading forces. They are generally diversified portfolios focused on core property sectors. Liquidity limitations are similar to interval funds, but NAV REITs have more discretion than interval funds and can shut down redemptions during periods of portfolio stress. Federally, investors are required to meet moderate income and/or asset thresholds to invest in NAV REITs. Many states have additional requirements or limitations.
Private Placements are relatively small, narrowly focused, and riskier investments. They may be for new development, renovation projects or even rehabilitating distressed properties. Utmost care must be taken to evaluate the managers, strategy and track records. There are no liquidity windows and in some cases no income distributions. They bring the higher Accredited Investor standard, which is for millionaires or exceptionally high earners.
Delaware Statutory Trusts (or DSTs) are designed to accept 1031 Tax-free Property Exchange proceeds. Current tax law allows real estate sellers to defer capital gains by reinvesting all proceeds into a replacement property, or DST that owns replacement properties. DSTs may be illiquid for 10 years or more. They are also only available to Accredited Investors.
1 Registered Representatives that work through Broker/Dealers are entitled to charge these commissions, which are usually in the 6% – 7% range. Investment Advisors, who are held to a Fiduciary Standard, do not charge commissions for investments.
Article 4 of 5: Real Estate As An Investment Option
This is the fourth in a series of five pieces to help investors understand the benefits of owning commercial real estate, then differentiate the dynamics and variety of ownership channels.
Our first blog in this series explains how commercial real estate investments enhance traditional stock and bond portfolios.
Briefly, real estate generates most of its returns from rental income, can diversify a traditional stock and bond portfolio, and typically holds value during inflationary periods.
Indirectly holding real estate through stocks and mutual funds often dilutes these benefits, as they are subject to market volatility. Real estate stocks offer attractive dividends, but as demand raises the stock price, their yield goes down. Real estate funds can reflect a broad (indexed) composite of the market, but this washes out the opportunities of manager selection.
Owning private commercial real estate means investing through a pooled investment vehicle that is not listed on a stock exchange. Non-traded real estate portfolios often pay higher yields and better retain value.
Since private real estate is not publicly traded, it is not subject to the market volatility responsible for much of the fluctuations of traded REIT or mutual fund prices. Non-traded funds typically are priced at their Net Asset Value (the value of their assets minus liabilities).
Mutual fund managers must sell their holdings at lower prices during periods of high redemptions. Non-traded funds avoid these pitfalls by limiting redemptions, so they are not appropriate for short-term investors.
Private real estate investment managers look to increase profits by focusing on opportunities.
When you buy stock in a traded REIT, you’re buying it from someone who wants to sell their shares, but the real estate portfolio itself isn’t changing. Investors in private offerings are adding new money to a portfolio, allowing managers to be strategic in putting that money to work, looking at real estate dynamics for today’s opportunities. To see how Integras Partners incorporates real estate and other “Real Assets” click below.
Article 3 of 5: Real Estate As An Investment Option
This is the third in a series of five pieces to help investors understand the benefits of owning commercial real estate, then differentiate the dynamics and variety of ownership channels.
Many investors get started in real estate by owning one or more individual properties.
They may elect to rent a former home, acquire a property that already has a tenant, or inherit a property that they decide to rent. In this case, the owner must choose to engage a property manager or become the landlord. In addition to dealing with tenants, repairs, and maintenance, there are periodic costs for roofs, painting and prepping between tenants.
Rather than become a landlord, an investor may choose to get exposure through real estate securities, in the form of mutual funds, exchange-traded index funds or a host of public REIT stocks. These allow investors to own a slice of a professionally managed real estate portfolio, made up of hundreds or thousands of properties.
Public real estate securities trade on major stock exchanges, so they can be easily bought and sold.
Because they are publicly traded, they are priced based on market supply and demand, and are more correlated to corporate stock than private, or non-traded, real estate investments.
Non-traded REITs give investors the advantage of owning private real estate while avoiding the fluctuations of public markets. Click below to learn more about private real estate investments.
Article 2 of 5: Real Estate As An Investment Option
This is the second in a series of five pieces to help investors understand the benefits of owning commercial real estate, then differentiate the dynamics and variety of ownership channels.
Two investors that each own Amazon stock own the same investment; however, two investors that each own warehouses leased to Amazon do not. All commercial real estate (CRE) is different and can be categorized and analyzed in many different ways.
CRE Sectors
The heart of every major city is the Central Business District, which is home to the “core” sectors of Office, Industrial, Multi-Family, and Retail which make up the bulk of CRE, and are typically the most expensive buildings. They are often owned by large institutions i.e., insurance companies or pension funds as portfolio diversifiers. Satellite sectors include hotels, regional malls, self-storage, data centers & even cell towers. Each sector has unique demand drivers and sensitivity to economic factors. Many investors diversify their real estate holdings across multiple sectors.
Geography and Demographics
The most valuable domestic markets are the “Gateway Cities” of Boston, New York, Miami, Seattle, San Francisco & Los Angeles. Industrial warehouses are more valuable closer to the ports of Houston, Savannah, and Long Beach, CA because of their import traffic. CRE gets more affordable in smaller markets. Every geographic center can then divided by “sub-markets”, which might be identified by average household income or education level, proximity to transportation, or other magnets like schools and shopping. The size and characteristics of a market’s population have a major influence on real estate. Demand for apartments, for example, is higher near universities, military bases, hospitals, or other major employers.
There is an expression that All Real Estate is Local, which speaks to the need for knowledgeable community members when evaluating the merits of owning a particular property.
Risk / Return Characteristics
Real estate investments can also be categorized by their risk/return characteristics. The spectrum can be categorized as Core, Core Plus, Value-Add, and Distressed. Core properties generally have high occupancy and stable tenants. The steady income stream and predictable cash flows put core properties on the more conservative end of the real estate spectrum.
As you move down the spectrum from core-plus to distressed, properties have greater cash flow uncertainty and capital improvement needs. Investors may choose properties with greater risk for the possibility of greater capital appreciation.
Additional metrics in determining a building’s category can include age, design characteristics, and remaining lease terms.
As you learn more, it becomes readily apparent that investors need to rely on experts to determine the best buildings for any portfolio.
Article 1 of 5: Real Estate As An Investment Option
This is the first in a series of five pieces to help investors understand the benefits of owning commercial real estate, then differentiate the dynamics and variety of ownership channels.
For centuries, the two asset classes creating the most wealth have been stocks and real estate. Today, most people’s first investments are in stocks or stock funds. Established investors should consider adding real estate investments to enhance their portfolio.
Real estate has a different return composition.
Over the long term, U.S. stocks (i.e., the S&P 500 Index) have averaged annual returns in the 11% range. This comes mostly from appreciation and a modest (around 2%) dividend. Established real estate investments have comparable total returns, but a different return composition, with about 70% of the return coming from income. There are also tax advantages that can improve after-tax return. Both stocks and real estate investments can benefit from long-term capital gain tax rates, but real estate can offer additional tax benefits from pass-through depreciation.
Real estate has a lower risk profile than stocks.
Stock prices can fluctuate dramatically with quarterly earnings surprises, broad stock market gyrations and investor emotions. Real estate prices are driven by demand, net operating income (NOI), and interest rates, which all move more slowly. Demand can be driven by sector (apartments or warehouses, e.g.) or by the growth or decline of a specific market. Rising borrowing costs can restrict net income, however this is often offset by price appreciation in an inflationary environment.
Real estate behaves differently than stocks during economic cycles.
Stock prices are driven by earnings expectations and rise or fall in anticipation of changes in corporate earnings and broader economic forces. Building values tend to be much more stable through cycles, as values are determined by consistent rental income rather than less predictable corporate profit expectations.
Geography and sector diversity are important considerations.
The types of buildings you invest in and their location are important. Population shifts, regional economies, state-specific tax and business climates all impact real estate.
To learn more about how real estate can be classified by sector, location, and risk/return characteristics, read the next blog in our real estate series, “All Real Estate Investments are Different”.
