Oaktree Capital insights on investing in real estate.
In this paper we seek to provide information on investing in real estate as an asset class. We will explore the following five topics to help provide a foundation for investing in real estate:
- What is real estate?
- What are the potential benefits of investing in real estate?
- What are the different ways to invest in real estate?
- What is the current opportunity in the real estate market?
- What is Oaktree’s approach to real estate investing?
Oaktree Capital – What Is Real Estate?
At its core, real estate is tangible, real property consisting of land and the buildings on it. Generally, when most people think of real estate as an investment asset class, they divide it into two principal categories: commercial and residential. Commercial real estate typically refers to income-producing properties including office, retail, industrial/warehouse, hotel and multifamily rental apartment properties, in addition to sub-segments of the market like self-storage, manufactured housing and healthcare. In the United States, most large occupants of commercial real estate pay rent for the use of space instead of purchasing the space outright. Owners of commercial real estate typically receive monthly income in the form of rent from the tenants in the building. Residential real estate, on the other hand, refers to residential lots or dwelling units usually comprising single-family homes and condominiums that are mainly owned for personal use. The size of these markets in the United States is vast, with a commercial real estate market of $14 trillion1 and a single-family home market of $22 trillion2. Beyond commercial and residential, there are many other forms of real estate-related investments, such as real estate-intensive operating companies, securities, real estate investment trusts, loan pools and real estate debt.
Oaktree Capital – What Are The Potential Benefits Of Investing In Real Estate?
Some of the potential benefits of investing in private real estate include the opportunity for attractive total return, inflation protection, and low-to-moderate correlation to other asset classes.
Potentially Attractive Total Return
Real estate has historically generated attractive returns for its investors according to the total returns of the NCREIF Property Index and MSCI US REIT Index (“RMZ”) as noted in Table 1 on the following page. The combination of current income and capital appreciation is particularly appealing, as investors look for both to contribute to returns.
Potentially Hedge against Inflation
Interest rates in the United States have hovered at historic lows for a multi-year period, with the 10-year Treasury remaining below 2.5% for almost seven years. “Easy money” policies – particularly when in place over protracted periods – cause many investors to be concerned about inflation and its value-eroding effect. Real estate lease contracts commonly include Consumer Price Index (CPI) or fixed upward lease escalators. Thus real estate, whose value typically rises in an inflationary period, can be purchased as a potential inflation hedge. Further, U.S. property leases, which are periodically reset or negotiated, will adjust rents in accordance with supply and demand.
Real estate, and specifically private real estate, has historically displayed low correlation relative to stocks and bonds. This characteristic can be particularly beneficial when investors think about allocating capital within a broader portfolio. Table 2 shows the historical correlation of the NCREIF Index to other major asset classes.
Oaktree Capital – What Are The Different Ways To Invest In Real Estate?
Investors looking to allocate capital to real estate have many options that offer a range of benefits, risks and return profiles. In this paper we will explore the main strategies through which equity investments can be made in public or private real estate, either directly or through a fund structure.
Real Estate Investment Trusts
Real estate investments trusts (“REITs”) come in both public and private forms; invest in either equity or debt; and are required to distribute at least 90% of their taxable income annually in the form of dividends. Equity REITs are companies whose primary business is owning and operating real estate properties, usually within a specialized property type such as office buildings, multifamily rental apartments, shopping centers or industrial properties. Mortgage or specialty finance REITs, a much smaller group in size and number, invest in residential or commercial mortgages, loans or sale-leasebacks.
Most investors are familiar with large public REITs, which typically own high-quality properties in primary markets and are professionally managed either internally or externally. These REITs generally have access to capital markets for debt and equity financings, and thus can potentially benefit from a low cost of capital and flexibility within the capital structure. Additionally, they tend to benefit from operational efficiencies, especially in tenant retention in the retail space.
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