Commercial Real Estate: An Essential Building Block of Client Portfolios

Adding Value through Perspective

Most wealth management professionals want to be viewed as seeing the bigger picture—not only in terms of recognizing the broader scope of investment opportunities out there, but also by having viewpoints informed by an understanding of market cycles and an historic perspective. That’s the kind of knowledge most clients don’t possess, and that’s why they’re willing to pay for financial advice.

In 2022, rising interest rates triggered a market meltdown in which both stocks and bonds declined in tandem. That event put a spotlight on advisors, distinguishing those who added value to client portfolios through meaningful asset class diversification from those who used the traditional 60%/40% stocks-to-bonds allocation, which did not live up to its historic claim to provide bond-market ballast during times of equity market turbulence.

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As a result of that time, more advisors have looked to alternative assets to fill key portfolio needs for reducing risk and identifying sources of income and growth beyond traditional markets¹. Among the alternatives, commercial real estate has stood out for a track record that includes a number of attributes.

Potential Benefits of Commercial Real Estate (CRE)

1. The ability to reduce overall portfolio risk. Low correlations mean CRE prices typically move independently of stocks and bonds. Combining asset classes that move independently is a way to reduce portfolio volatility².
2. Inflation protection. The price of the properties that make up a CRE investment may increase over time. In addition, contracts and rents can often be adjusted higher as leases renew, providing a hedge against inflation.
3. Passive income. CRE provides income streams sourced from rent and lease payments, which are influenced by factors different than those affecting stock dividends and bond yields, thus providing an added layer of diversification.
4. Return potential. Investors in CRE can at times benefit from higher returns linked to an operator’s ability to identify pockets of opportunity within less efficient markets.

Types of CRE

CRE spans a range of property types, including office, industrial, retail, multifamily, hotels/hospitality, and specialized sectors like data centers (lately driven by AI), healthcare, and storage. Each has its own risk/return/income characteristics.

Compared to raw land, CRE is known for having higher earning potential and greater stability making it a choice to consider for client diversification needs. The two main approaches to CRE investment vary by level of investor involvement:

Today’s Moment in the Real Estate Cycle

Real estate markets are cyclical, driven by changing demographics, shifts in interest rates and a range of economic factors. For this reason, we believe advisors should set realistic return expectations among clients and encourage them to adopt a long-term time horizon for their real estate investments.

At Forum, we see a number of reasons to be bullish on the Multifamily sector of CRE. Landlords within the space are generally able to raise rents more quickly than those in sectors with longer leases, such as office and industrial. In addition, higher mortgage rates and the ongoing national shortage in housing have provided pricing support for Multifamily rents. At the end of 2023, the average monthly new mortgage payment was 38% higher than the average apartment rent³. Finally, we have seen an uptick in attractive buying opportunities as owners of quality properties that have been negatively impacted by higher interest rates are now deciding to sell.

Conclusion

Today, evidence of knowledge tops the list of qualities clients seek in their financial advisors⁴. Portfolio construction that is well informed and that includes asset classes like CRE that are less correlated with traditional markets has become an essential way for advisors to demonstrate their knowledge and the value they bring to client relationships.

¹Source: Mercer; “The State of Alternative Investments in Wealth Management 2023” – 2023, accessed October 1, 2024.
²Source: CFA Institute; “Don’t Forget Diversification, by Gary Sanger, PhD, CFA” – April 11, 2024.
³Source: CBRE Research, CBRE Econometric Advisors, Freddie Mac, U.S. Census Bureau, Realtor.com%, FHFA, Oxford Economics, Q1 2024. Note: Does not include estimates for homeowner’s or renter’s insurance.
⁴Source: The American College of Financial Services; “What Do Clients Want from Financial Advisors?” – March 1, 2022.