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In partnership with Goldman Sachs Wealth Management
  1. Goldman Sachs Private Wealth Management
December 8, 2022updated Dec 12, 2022

Things to Consider When Investing in Private Real Estate

During periods when markets are less predictable, real estate may be able to add stability to your portfolio.

By Elite Traveler

Private real estate is a major sub-sector within the alternatives market and can be a good way to diversify your portfolio. Currently the real estate industry is responding to complicated market dynamics as well as widespread changing consumer preferences.

It is expected that some of these trends will create interesting opportunities across the real estate market. There are several investment themes you may consider exploring.

Rising home ownership and construction costs, population and employment growth, and demographic trends are shining a light on housing supply issues in the United States. This climate produces unique chances to develop new multi-family and single-family rental assets to meet the growing demand and help address housing concerns. Geographically, markets with lower costs of living and business-friendly regulations, such as Austin, Nashville or Charlotte, have seen outsized population and job growth, creating interesting investment opportunities as well.

Pent-up demand for travel and experience-based spending is increasing, as travel and government restrictions ease.1 This, combined with the COVID-19 related dislocation experienced across assets such as hotels, restaurants and recreational centers, can form attractive investment conditions within the travel and leisure sector over the short and long term.

The retail sector is undergoing long-term structural shifts on both the supply and demand sides. As e-commerce continues to transform how we consume products, retailers are adjusting their distribution networks, focusing on maintaining inventory close to the consumer and strengthening their supply chains to handle buyers’ preferences for accessibility and immediacy. This has created strong demand for warehouse assets located in dense, urban markets where land can be limited, creating opportunity in the logistics sector.

While the future of the general office market is still uncertain, use of office space in major metropolitan areas is experiencing an upward trajectory relative to the past few years.2 Within these cities, adaptable, modern office space is increasingly in demand from tenants.3 Broader macro trends, including the shift to more flexible work environments, increased content creation spend and tailwinds around healthcare innovation, are driving demand for more specialized office space, such as studio and media offices and life science assets, which we expect to continue over the long term.

Ceder Park a suburb of Austin, Texas / ©Getty Images

5 reasons you may consider real estate in your portfolio

Diversification

Private real estate has historically exhibited less correlation to traditional asset classes, such as public equities and fixed income, though access to private real estate comes with the risk of less liquidity.4 Supply and demand dynamics, as well as migration trends, job and population growth, may impact private real estate differently than equities and fixed income. By diversifying your portfolio, you can often mitigate risk.

Inflation Hedge

Real estate income streams have the potential to grow over time, as market rents grow or rent escalators built into leases step up, often outpacing inflation and contributing to real assets’ strong performance in periods of high inflation.5 Properties built with physical commodities like lumber and concrete can also offset inflation, though rising input costs may hurt growth.

Income

Properties that generate income through rent payments can offer investors stable, consistent distributions. Average annual yields for private real estate have been historically higher than other asset classes, including public REITs and fixed income.6 Asset depreciation and some investment structures can provide tax efficiency for income generated by real estate given certain government legislations.

Capital Appreciation

Real estate offers the potential for capital appreciation, as demographic trends and supply and demand imbalances may enhance property values. Changing market dynamics and consumer preferences can impact the supply and demand of real estate sub-sectors, which can lead to interesting opportunities for investors. Additionally, valuations in private real estate may take longer to reflect pricing changes.

Attractive Risk-Adjusted Returns

Real estate has historically contributed positively to portfolio returns. Investors should consider performance on a net basis given the impact of fees on returns.7 The range of potential returns tends to be narrower within private real estate; over the past 10 years, private real estate has had just a 2.5% standard deviation relative to public real estate at 14.9%.8

A few different ways investors can access real estate

In addition to investing in a single property, you can get exposure to real estate through the following vehicles:

Open-end private real estate vehicles often have an indefinite lifecycle, where investors can subscribe and redeem from the fund on a regular basis, usually monthly or quarterly (subject to certain limitations), and they may provide some form of current income to investors. Investor eligibility and suitability may vary based on the vehicle’s structure.

Non-traded REITs (“NTRs”) are a type of open-ended vehicle that are publicly registered with the SEC but do not trade on public exchanges. NTRs can typically be accessed through various types of wealth management channels and might have lower suitability requirements than other types of investment vehicles.

Closed-end private real estate vehicles have a finite lifecycle and tend to be more illiquid. Investors commit capital upfront, which is deployed over a period of time, and receive capital back usually only as underlying assets are sold.

Real estate in the current economic climate

Investing in real estate can often help investors take advantage of current market dynamics, including rising interest rates, rising inflation, and elevated market volatility.

Rising Interest Rates

Periods of rising interest rates have generally historically corresponded with strong private real estate fundamentals. Although the cost of borrowing to finance the purchase of real estate assets may increase, the total yield of real estate, or cap rate, continues to be in excess of the 10-Year U.S. Treasury Yield, providing positive financing leverage.

The spread between cap rates and the 10-year U.S. Treasury yield is currently ~210 basis points for major property sectors, which provides enough room between the two and could indicate that a rise in interest rates might not necessarily result in a corresponding rise in cap rate (or decline in real estate values).

Rising Inflation

Real estate rental growth and net operating income have historically kept up with or outpaced rising costs, serving as both an inflation hedge and source of reliable income for investors. As costs of land, construction, and other materials rise, the supply of new assets might be muted, which could create interesting investment opportunities.

Real estate income and inflation

©Goldman Sachs

Elevated Volatility

Quarterly returns, including both income and appreciation, for private real estate have historically remained more consistent than returns for public real estate, particularly during periods of elevated public market volatility. Certain strategies may be able to take advantage of volatility and invest into market dislocation.

©Goldman Sachs

While the markets may currently be difficult to predict, the inclusion of real estate within your portfolio can often be beneficial. A conversation with an advisor will provide personal advice that is crafted for you based upon your goals, liquidity needs and risk tolerance.

Endnotes

1 WTTC: U.S. Travel & Tourism Recovery Projected to Exceed Pre-Pandemic Levels in 2022. February 2022.

2 Goldman Sachs Global Investment Research. Americas Real Estate: REITs. Office 1Q22 Preview: Return-to-office improving. 18 April 2022.

3 Goldman Sachs Global Investment Research. Americas Real Estate: REITs. The Future of Office: Flight-to-New and Rising Obsolescence; KRC up to
Buy. 25 May 2022.

4 Goldman Sachs Global Investment Research. Global Strategy Paper No. 55: Balanced Bear Despair – Part 3: Strategies to keep it real with balanced
portfolios. 14 March 2022

5 Goldman Sachs Global Investment Research. Global Strategy Paper No. 55: Balanced Bear Despair – Part 3: Strategies to keep it real with balanced
portfolios. 14 March 2022.

6 Goldman Sachs Asset Management. Bloomberg, NAREIT, NCREIF.

7 Goldman Sachs Investment Strategy Group, Consumer and Wealth Management Division. Bloomberg.

8 Goldman Sachs Asset Management. Bloomberg, NCREIF

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This material is provided for informational purposes only and should not be construed as investment advice or an offer or solicitation to buy or sell securities. This material is not intended to be used as a general guide to investing, or as a source of any specific investment recommendations, and makes no implied or express recommendations concerning the manner in which any client’s account should or would be handled, as appropriate investment strategies depend upon the client’s investment objectives. The portfolio risk management process includes an effort to monitor and manage risk, but does not imply low risk.

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