When seeking out alternative investments, the first concern investors typically have is whether alternatives can outperform the public markets as well as the correlation of alternatives to public market options.
The most common public market benchmark investors use for comparisons is the S&P 500. As the S&P 500 index tracks a low entry cost, highly liquid investment environment, it is imperative for an alternative investment to bring something to the table in terms of targeted out-performance.
Specifically, for investors interested in real estate, public REITs are another benchmark. REITs own income-producing real estate. Since they’re publicly traded, many investors see REITs as an attractive option for adding real estate to their portfolio and the liquidity that exists when investing into them. The most popular benchmark for public REIT performance is the IYR (iShares US REIT ETF), which essentially serves as the S&P 500 of the REIT space.
Running the numbers, let’s look at how private real estate returns, in general, compare to public market options. For purposes of this comparison we’ve identified investor Fred, who is considering an investment of $500,000 in a private real estate fund. We will track private real estate performance by using the NCREIF (National Council of Real Estate Investment Fiduciaries) index. The NCREIF tracks the performance of a pool of private real estate investments held by institutional investors (think pension funds, endowments, etc). This provides an insight to how typical private real estate may function, as a consolidated benchmark. As a disclaimer it is nearly impossible to identify all private real estate transactions that occur in a consolidated resource and the NCREIF is one of the closest methods to use when comparing private real estate to public market investments.
Returns with Low Correlation
As you can see in the infographic, there were some years where the public markets (S&P 500 and IYR ETF (public REITs) outperformed the NCREIF (private real estate) when looking over a period from Q1 2005 through Q4 of 2015. There were also several years where the S&P and IYR under-performed.
More importantly, the NCREIF returns have demonstrated low correlation with the public market options presented. Market swings and volatility are general market risks and are important considerations to account for when you’re making long-term investment. In an age of volatility, where a black swan event can stir up market turmoil, political uncertainty, or world events, it can be impactful to consider diversification into assets not directly linked to the public market’s ebb and flow.
Consistent, Low Volatility Returns
Another important takeaway from this comparison are the consistent, low volatility returns of private real estate relative to the performance of the public market options. While the charts for the S&P 500 and IYR show multiple peaks and valleys, the NCREIF returns remained consistent over the identified period (except for dip related to the Great Recession).
You may ask yourself, why? Private real estate is typically consistent due to the nature of the hard asset. Most times when investing into this alternative investment you’re a direct investor into one asset (individual syndication) or an investor into many (a private real estate fund). Real estate at its core typically does not change in value quickly and can be directly managed through cycles or outside impacts with the right sponsor (read more about this in our article 17 Questions to Ask Before Investing Your Money).
Public REITs are NOT the same as investing in private real estate even though REITS only own real estate. In fact, from 1/2/18 to 2/8/2018, Public REITs (as measured by the IYR ETF) dropped a whopping 11.4% as the US 10-year Treasury rate rose from 2.43% to 2.85%. This period is a great example of the core difference between investing in REITs and private real estate. Real estate, at its core, does not change in value this quickly.
While you might assume that public real estate investing vehicles such as REITs share the same low correlation, they don’t. Public REITs are highly correlated to the S&P 500. A volatile stock market combined with increasing treasury rates may have many investors questioning the direction of the market and if their asset allocation has them prepared for what is to come, for example. Instead of losing sleep at night worrying about what’s next in the public markets, consider more stable alternatives like private real estate investments.
The Difference is Clear
Compared to the public markets, private real estate historically has delivered consistent, low volatility returns, with a low correlation to public market options (S&P 500, IYR).
These consistent quarterly returns (on both an absolute basis and a rolling-average basis) should be considered by investors conducting due diligence on alternative investments.
Private real estate has a very low correlation (0.18) with the S&P 500, making it a great diversification asset class consideration for your overall investment plan.