Considerations for Integrating Private Real Estate into a Diversified Portfolio
For advisors who have grown to appreciate the potential benefits of private real estate investments—such as compelling returns, increased income, reduced volatility, and enhanced diversification—their attention quickly turns to allocation and integration. How much private real estate, and what kind? How can real estate be effectively added into a diversified portfolio?
As with any investment, there is no uniform answer here; each portfolio is unique. That said, several important factors should shape the process. In this article, we touch on four influential considerations:
- The investor’s current situation and financial goals
- The different types of private real estate strategies
- Context from institutional investor allocations
- Model outcomes
Start Here: Investor Goals, Time Horizon, and Risk Tolerance
To help determine what role private real estate can play in a portfolio, it’s imperative to start with a thorough understanding of the investor. Different risk profiles and objectives align with different allocation plans. The investor’s particular situation will influence the type and size of the private real estate allocation and which existing allocation should be reduced and redirected toward real estate.
Fruitful conversations to fully understand an investor’s financial position feature detailed discussion of:
- Overall wealth, including accredited investor status and ability to meet investment minimums
- Investment goals, time horizons, and liquidity needs, including major planned purchases and estate planning objectives
- Risk tolerance, including sensitivity to volatility
- Tax considerations, including estate planning objectives, capital gains, and income changes
Is the investor seeking income as they move closer to retirement, or is capital appreciation the top priority for a growth-oriented investor focused on absolute returns? Perhaps the investor lands somewhere in the middle, pursuing a blended approach. Armed with this information, advisors are better positioned to understand how private real estate investments may align with an investor’s particular situation and tailor their allocations accordingly.
Different Private Real Estate Strategies: Understand the Risk Profiles
Private real estate investments fall into four broad categories: core, core plus, value add, and opportunistic. While the definition may vary a bit from sponsor to sponsor, these four broad buckets do a good job communicating the expected risk and return profile; therefore, they are critical for helping advisors identify and integrate optimal portfolio allocations.
Core
Core real estate investments represent the most conservative blend of risk and return in the private real estate segment. Core properties tend to be built exceptionally well, located in great areas, and burdened by very few deferred maintenance requirements. Core assets typically have high-quality tenants already in place with long-term leases. These properties are usually new or very close to new, with minimal capital expenditures needed each year. Investors can expect few—if any—surprises with these assets.
As you drive through a city center and see a high-rise glass office building with premier tenants, that’s likely a core asset. If you see a beautiful luxury apartment building in a prime location, that’s also likely a core asset.
When you invest in a core real estate fund, you’re investing to access a portion of the properties’ cash flows right now. As such, current income represents the bulk of the fund return.
Another way to think about the core category is to consider who buys core real estate assets. In large part, the buyers are big institutional investors, such as pensions and endowments. For these institutions, the key advantage of core real estate is its low relative risk profile. In addition, core real estate strategies can often accept large amounts of capital—an important capability sought by institutions with big chunks of money to put to work.
In terms of disadvantages, core real estate strategies don’t offer much potential for appreciation, making them less suitable for investors seeking growth or a blend of growth and income. Low risk goes hand-in-hand with low return—so the returns of a typical core real estate investment may not be sufficient to meet some investors’ financial goals.
Core Plus
Core plus real estate investments involve properties that are very similar to core properties, but, for one reason or another, they don’t quite fit into the most conservative category.
Consider, for example, an asset in a Class A location—perhaps right in the middle of a city’s bustling downtown district. If the building itself is Class A, then this would be a core asset, but if the building is Class C—maybe a tired 1970s apartment building—it will land in the core plus category.
Leverage is another reason an asset could move into the core plus category. If you have a Class A location and a Class A building that could be considered a core asset, but you’re using more leverage than typically seen in a core strategy, then the asset will move into the core plus category due to the higher risk profile.
Core plus assets are typically income-producing properties that are well leased—maybe not leased to the absolute highest quality tenants, as you would expect with a core asset, but the tenant base is still creditworthy and there is likely a history of leasing the property successfully. Most core plus assets are stable, meaning they don’t require the buyer to complete extensive renovations or figure out a way to get from 50% occupied to 95% occupied.
Many individual investors, family offices, and small institutions are drawn to core plus real estate as long-term investments. Core plus real estate investments offer the advantageous ability to earn a significant portion of returns through cash flow while also earning decent appreciation. For investors looking to grow long-term wealth and/or preserve wealth over multiple generations, core plus real estate strategies can be a “sweet spot” that take a bit more risk than traditional core funds, enabling the investment to grow at a pace that outruns inflation. That said, some investors may see the additional risk embedded in core plus real estate funds as a potential disadvantage.
Value Add
Leverage, risk, and potential return all increase in the value add category. As the name implies, the goal is to find properties priced below the market that need some work to restore their value. Sponsors work to transform management, operations, and/or the physical asset. These efforts can include replacing the management team, adjusting the operational strategy, upgrading appliances, changing out carpet and paint, or improving amenities like parking lots and pools. The strategy often involves buying an existing property operating at 50-90% occupancy, then transforming the property while maintaining occupancy to maintain cash flow. At exit, investors are offering a clean and simple core or core plus stream of income to the next buyer.
Opportunistic
Opportunistic projects can include developing something from scratch (ground-up development), repurposing a building from one use to another (adaptive reuse, for example, changing a medical office into an assisted living facility), and winning entitlements for raw land. This category lands at the far end of the risk-return spectrum, given the complexity and difficult nature of these projects.
Hybrid
In addition to the four broad strategies outlined above, real estate investments can combine elements of the strategies in various ways, resulting in a “hybrid” risk-reward profile. We could even say core plus strategies are a type of hybrid: They combine core assets with a bit more debt and perhaps require some renovations—thus creating a blend of the traditional core and value add strategies.
Let’s consider an example: One common hybrid opportunity zone strategy is known as “development to core.” The sponsor builds an asset from scratch, stabilizes the property, then holds it for cash flow—all within the same Qualified Opportunity Fund. This strategy is intended to deliver significant appreciation in the first three to five years, then become a consistent income-producing investment in its final few years. And because this strategy is implemented within a Qualified Opportunity Fund, investors can capture tax savings—a powerful benefit, given the detrimental effect taxes can have on a portfolio’s total return.
Studying the Smart Money: Institutional Allocations
Alternative investments, including real estate, can create meaningful opportunities to grow wealth and bolster portfolio diversification. Elite investors are certainly aware of this dynamic, including pension plans, insurance companies, sovereign wealth funds, and endowments. For example, Cornell University’s Baker Program in Real Estate and Hodes Weill & Associates gathered data from more than 150 institutional investors worldwide and found that target real estate allocations reached 10.8% in recent years.1
A report from UBS paints a similar picture among ultra-high-net-worth investors, finding that family offices allocated 10% to real estate in 2023, part of their 42% allocation to alternative asset classes. The survey featured responses from 320 family offices worldwide managing an average of $1.3 billion.2
Many individual investors, however, fall short of these levels, allocating single-digit percentages to alternatives in general, and even less to real estate. Not every individual can build a portfolio that mimics institutional holdings—nor would it be wise. That said, individual investors can still apply similar principles to their own portfolios, positioning themselves to achieve higher levels of risk-adjusted return.
Modeling the Impact of Real Estate in Portfolios
To assess how an allocation to private real estate can help portfolios, experts often model historical portfolio outcomes. In one such exercise, published by the Chartered Alternative Investment Analyst Association, the team at Cohen & Steers found that a moderate investor portfolio benefited significantly from a 12.5% allocation to real estate (5% private and 7.5% listed):3
Take a moderate investor, for example; someone seeking a balance between growth and income and who has a medium risk tolerance. We assume a typical allocation for this type of investor would be a default portfolio of 60% stocks and 40% bonds.
Cohen & Steers’ best thinking for that same investor is to allocate 12.5% of their portfolio to real estate (5% private and 7.5% listed). The historical result … is that by diversifying with real estate, that investor would have improved performance with a similar level of volatility and a more favorable risk/return profile. Compounded over time, these differences are significant.
Standard Stock/Bond Portfolio
| Annualized performance over last 30 years | |
| Return | 8.2% |
| Volatility | 9.8% |
| Sharpe ratio | 0.60 |
Portfolio with Real Estate
| Annualized performance over last 30 years | |
| Return | 8.4% |
| Adjusted volatility* | 9.9% |
| Adjusted Sharpe ratio* | 0.61 |
The 30-year analysis was based historical returns on the S&P 500 for equities, the Bloomberg Barclays U.S. Aggregate Corporate Index for bonds, the FTSE Nareit Equity REITs Index for listed real estate, and the NCREIF ODCE Index for private real estate, which follows a core investment strategy.
Caliber’s Advisor Resource Hub
Portfolio construction and asset allocation present ongoing challenges for advisors. When it comes to private real estate, our team at Caliber is here to help. As a partner, we guide registered advisors and representatives through the complexities of this robust asset class. We provide comprehensive resources and services at every step, ensuring a positive and seamless investment experience. Visit our Advisor Resource Hub to learn more.
1 Cornell University Baker Program in Real Estate and Hodes Weill & Associates 2024 Real Estate Allocations Monitor, https://www.hodesweill.com/real-estate-allocations-monitor
2 UBS Global Family Office Report 2024, https://www.ubs.com/global/en/wealthmanagement/family-office-uhnw/reports/global-family-office-report-2024.html
3 CAIA Association, The Case for Strategic Allocations to Listed and Private Real Estate, Jeffrey Palma, Rich Hill, Joseph Handelman, Cohen & Steers, January 2024, https://caia.org/blog/2024/01/29/case-strategic-allocations-listed-and-private-real-estate. 30-year data as of 12/31/2022.
*When using historical data for portfolios with private real estate, the authors apply a method to “de-smooth” the volatility in an attempt to better reflect actual swings in asset values. Adjusted volatility shows this recalculated measure of volatility, whereas reported volatility reflects what was reported by funds.
About Caliber (CaliberCos Inc.) (NASDAQ: CWD)
With more than $2.9 billion of managed assets, including estimated costs to complete assets under development, Caliber’s 16-year track record of managing and developing real estate is built on a singular goal: make money in all market conditions. Our growth is fueled by our performance and our competitive advantage: we invest in projects, strategies, and geographies that global real estate institutions do not. Integral to our competitive advantage is our in-house shared services group, which offers Caliber greater control over our real estate and visibility to future investment opportunities. There are multiple ways to participate in Caliber’s success: invest in Nasdaq-listed CaliberCos Inc. and/or invest directly in our Private Funds.
Investor Considerations
The information contained herein is general in nature and is not intended, and should not be construed, as accounting, financial, investment, legal, or tax advice, or opinion, in each instance provided by Caliber or any of its affiliates, agents, or representatives. The reader is cautioned that this material may not be applicable to, or suitable for, the reader’s specific circumstances, desires, needs, and requires consideration of all applicable facts and circumstances. The reader understands and acknowledges that, prior to taking any action relating to this material, the reader (i) has been encouraged to rely upon the advice of the reader’s accounting, financial, investment, legal, and tax advisers with respect to the accounting, financial, investment, legal, tax, and other considerations relating to this material, (ii) is not relying upon Caliber or any of its affiliates, agents, employees, managers, members, or representatives for accounting, financial, investment, legal, tax, or business advice, and (iii) has sought independent accounting, financial, investment, legal, tax, and business advice relating to this material. Caliber, and each of its affiliates, agents, employees, managers, members, and representatives assumes no obligation to inform the reader of any change in the law or other factors that could affect the information contained herein.
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