Real Estate

These are investments in real estate assets with the objective of generating current income and/or reselling at a higher value in the future. Real estate usually refers to the commercial sectors of office, retail, industrial and the leased residential sector. Increasingly, real estate investment also refers to debt secured against property assets. Real estate can offer a range of investment characteristics with different risk levels. The lower end of the risk spectrum includes core investments which are focused on stable income streams, available from high quality tenants secured on long leases. Risk is reduced when a building is already operational and generating income. Loans made to high quality borrowers which are secured against properties with predictable cash flows can also be classified as core investments. Riskier investments that aim to improve either the physical environment or the security of the income profile of existing properties are commonly referred to as value-added and opportunistic strategies. Often with these strategies, vacancy rates are higher, lease lengths are shorter and tenant covenants are less secure than core properties. The riskiest investment strategies include real estate development, which involves new buildings being delivered to the market, and purchasing distressed property assets or distressed debt secured against real estate at discounted values.

We believe that the main concern for those investing in real estate is the limited liquidity of the asset class, which is defined as the ability to turn an individual property asset into cash or convert cash into the asset. Real estate suffers from two sources of illiquidity. The first relates to the mismatch between pricing and values, and the second due to the delays inherent in the purchase and sale process. In a market which relies upon valuations as proxies for pricing, liquidity is likely to be impaired during periods where values and prices differ from one another considerably. This is particularly evident in sharp downturns, where values tend to lag prices because of the limited transactional evidence available to valuers in making appropriate assessments of current pricing. The illiquidity is often amplified because investors may be reluctant to sell at a price that departs significantly from the last valuation. In markets where prices and values do not differ considerably, trading often takes place over a reasonable time frame. In periods of market stress or dysfunction, it will often take longer for investors to buy or sell assets or to enter or exit unlisted funds. The sector’s limited liquidity is most often mentioned during periods of credit stress when investors are looking to reduce their exposure. However, as compensation, an illiquidity premium is expected to be earned for funds being locked-up. ActiveAllocator algorithms calculate the illiquidity premium when assigning it a place in the overall allocation.

ActiveAllocator helps you allocate to multiple ways to gain exposure to real estate.

  • Private and public equity real estate

    • The private equity market via direct investment, unlisted funds or a fund-of-funds vehicle; and

    • The public equity market via indirect investment through real estate company shares or Real Estate Investment Trusts (REITs).

  • Private and public debt real estate

    • Through the private debt market by providing loans to finance the purchase of real estate assets; and

    • Through the public debt market by investing in bonds that are secured against real estate assets.

To assess the merits of investing in real estate, we conduct analysis using published indices. This brings with it various issues related to the way in which real estate indices are compiled from valuations rather than prices – taken together these issues are known as ‘valuation smoothing’. The impact of smoothing biases those statistics in real estate’s favor, including the volatility of returns, the correlation of returns between different sectors and markets, and the correlation of returns with those of other asset classes. We believe that ‘valuation smoothing’ reduces the reported volatility of the asset class below the real level of risk suffered by investors who have to sell in a weak market or purchase in a strong market. We use adjusted data to account for the smoothed valuations.