Does Real Estate Deserve a Larger Role in the Ideal Future Portfolio?

For the better part of a century, investors have enjoyed robust returns through public equities. Since 1930, the S&P has given an annual return of approximately 11%, with an impressive 13% annual return over the last decade. When adjusted for inflation, the S&P’s real return has been roughly 7% annualized on average or 10% annualized over the past 10 years. This remarkable performance has been fueled by a combination of factors including, but not limited to, productivity gains and innovation, globalization, government and monetary policy, and population growth.

While we’ve become accustomed to these returns, it’s worth remembering, as Goldman Sachs recently pointed out, “past performance is not indicative of future results.” Over the next decade, the firm is projecting an annualized return from the S&P 500 of just 3%, not adjusted for inflation. Goldman also noted that there is a 33% likelihood that the S&P will not outpace inflation. While this is their base case, their range of projections only reach as high as 7% annualized, while as low as -1% annualized return over the next 10 years. This is in high contrast to the cumulative 233% historical return seen in the last decade. This projection, influenced by historically high valuations, increased market concentration, and expectations of economic slowdowns may prompt investors to reconsider their strategies and begin seeking compelling alternatives.

Why Consider Private Real Estate?

So, what does this mean for investors looking to reposition their portfolios and maintain healthy returns? While we may be a bit biased, we believe that private real estate presents an exceptional alternative in today’s landscape. There are numerous benefits of commercial real estate, which we’ve discussed in previous posts, such as:

1. Capital preservation
2. Attractive yields
3. Consistent and relatively determinable and dependable cash flow
4. Potential tax benefits

The current and future economic environment raises the question: “Does real estate deserve a larger role in the ideal future portfolio?”

The Federal Reserve has sent a clear signal, cutting interest rates by a total of 75 basis points, as of November 7, 2024. Experts debate its appropriateness and speculate on what’s next, but this was a decisive pivot. Additional cuts are anticipated, though their timing and extent vary among analysts. The Fed itself projects its benchmark rate to near 3% over the next two years – a sharp decline from the 5.25% to 5.5% peak first reached in July 2023 and held until September of this year.

Real Estate’s Advantage in a Low-Interest Rate Environment

In an environment of tempered expectations for real risk-adjusted returns, real estate presents a unique opportunity in an increasingly accommodative policy period. The anticipated dovish monetary stance could positively impact real estate in several ways:
 

1. Lower Borrowing Costs: With a reduction in the cost of financing, investors and developers will be able to secure loans at lower interest rates, making it more affordable to finance new acquisitions or refinance existing debt.
2. Increased Property Values: As borrowing becomes cheaper, property valuations are expected to rise. Lower interest rates tend to compress cap rates, which investors use to evaluate returns on properties. Therefore, buying assets now should lead to favorable appreciation as cap rates continue to compress over the next few years.
3. Stronger Market Liquidity: Better financing conditions are likely to attract more investors, boosting liquidity and facilitating more demand and quicker exits for sellers.

What the Political Landscape May Mean for Real Estate

The 2024 election season was tumultuous, and many are relieved to look to the future. What does this mean for commercial real estate? We anticipate a shifting landscape influenced by fiscal, tax, and regulatory policy changes, similar to those seen in President Trump’s first term with the Tax Cuts and Jobs Act. With Republicans set to control both the White House and Congress, we expect a renewed emphasis on investment incentive programs and expanded deductions for real estate – factors likely to benefit the commercial real estate environment.

We’ll share more on this topic soon, but for now, it’s worth considering:

“Does real estate deserve a larger position in the ideal portfolio going forward?”

Takeaway

We’re in an evolving landscape with political, economic, and regulatory factors changing rapidly. For investors rethinking their strategies in light of this outlook, now may be an opportune time to consider the role that commercial real estate could play in a diversified portfolio.

At Excelsior Capital, our investment approach enables us to generate value for our investors, regardless of the fluctuations and uncertainties inherent in external market conditions. If you’re interested in learning more, please feel free to reach out to our team here.