Real estate or Global Property is the world’s largest store of wealth, valued at over $326 trillion, surpassing global equities, debt securities, and gold.
This article explores global property as an asset class, its investment vehicles, and whether it should be included in investment and pension portfolios.
We aim to give our clients an insight into our investment philosophy and why we exclude global property from the investments we recommend.
Property Types and Classes
Real estate is categorised into types and classes to assist investors in comparing properties efficiently:
Property Types:
Residential: This category includes apartments, single-family homes, and multi-family properties (less than four units). These generate rental income and potential equity growth.
Commercial: Designed to generate income, including hotels, office spaces, retail properties, and storage facilities.
Land: Divided into brownfield (previously developed land requiring cleanup) and greenfield (undeveloped land, often used for agriculture).
Property Classes:
Classified as Class A, B, or C, indicating quality and expected risk/return. Class A properties are high-quality, while Class C properties carry higher risk but potential for higher returns.
How can investors invest in property?
Investors have several methods to access property investments. They can invest in real estate through various means:
Direct Holdings: This involves owning physical property, which may be considered an illiquid asset requiring maintenance and expertise.
Shares in Real Estate Companies: For those unable or unwilling to hold property directly, owning shares in real estate companies is an option. However, this exposes investors to equity risk, as the value of shares fluctuates daily.
Physical Property Funds: These funds invest directly in retail, industrial, and commercial properties, providing rental income and potential appreciation. However, such funds may face restrictions that occasionally prevent investors from selling the asset.
Real Estate Investment Trusts (REITs): These specialised vehicles pool investor capital to own income-generating properties. REITs offer ease of access, diversification, and regular income but are sensitive to interest rates and market conditions.
A Comparison between REITs and Equities
A large proportion of fund managers now use REITs as a way of accessing assets within the Global Property Sector. REITs share characteristics with equities but have distinct features:
Performance Analysis: Historically, REITs have often followed equity market trends but have underperformed in recent years due to interest rate sensitivity, pandemic-related challenges, and the tech sector boom.
REITs’ Alignment with Factor-Based Stocks: Regression analysis can be used for in-depth analysis. A Study by French and Fama concluded that REITs behave and react like smaller, value-oriented, and profitable stocks. However, recessions or rising interest rates can significantly impact their returns.
Comparison of Performance and Returns
Although Global REITs may add some diversification to a portfolio, they can also reduce potential returns. A recent performance comparison has shown that REITs have underperformed against global equities. The graph below demonstrates this point.
Does Global Property offer Diversification Benefits?
Real estate is seen as a diversification tool in multi-asset portfolios, but its benefits are complex:
Although holding Global Property can provide some diversification, it usually comes at the expense of performance. If you believe Reits behave much more like equities, investors should not sacrifice returns for the perceived benefit of diversification.
A balanced portfolio of stocks and bonds can hold up to 22,000 individual holdings. This level of diversification is more than sufficient for most investors.
Global Equity Portfolios will already hold some property.
Many non-property companies hold significant real estate, providing indirect exposure:
Case Study: McDonald’s Corporation: McDonald’s owns 45% of the land and 70% of the buildings at its locations, integrating real estate into its business model. This shows how real estate impacts non-property firms.
Corporate Real Estate: Corporate real estate can represent 10-35% of total assets, indicating investors might already have substantial indirect exposure via equity portfolios.
The impact of property and financial planning
Many investors already hold real estate assets, such as residential properties. In the UK, private landlords own multiple properties, with 38% holding 2-4 properties and 8% owning over 20 properties. Adding REITs to portfolios may increase existing property exposure rather than diversify risks. Most clients own some property. Advisers should evaluate whether additional real estate allocation is appropriate for individual investors.
Conclusion
To summarise:
- The majority of Model Portfolio Services use Global Reits
- Global Reits behave like equities
- Performance is worse than comparable equities
- Many Global Companies hold substantial property assets
- The majority of our clients already hold or own some form of real estate or property
- There has to be a compeling reason for adding additional holdings
Real estate is a complex asset class with equity-like and fixed-income characteristics. While REITs can provide diversification and income, their necessity in portfolios depends on individual circumstances. Many investors already have indirect exposure through equities or direct property holdings, making additional allocation less imperative.
For this reason we exclude Global Property from the investment models we recommend.
Consilium Asset Management are Independent Financial Advisers, based in Chipping Sodbury, Bristol. Investment Performance is not guaranteed and the value of investments can fall as well as rise.
