Real estate investment can be classified by its ownership base and its capital structure.
Imagine a simple two-by-two matrix. One axis will separate real estate investment into “public” and “private” tranches, and the other axis into debt and equity.
So public equity in real estate includes instruments such as REITs and real estate stocks, while private equity involves direct ownership of real estate assets.
On the debt side, public debt includes various notes and bonds issued by real estate companies while private debt includes various loans that institutional investors lend directly to real estate operators.
Many real estate investors, especially asset managers that typically invest on behalf of institutional clients, eventually invest in all four quadrants of the above matrix.
We think that this development is a good case of convergent evolution as these quadrants offer interesting synergies to investment managers.
The first synergy is with the investment process. An equity house focusing on real estate stocks and REITs would typically have gathered deep intelligence regarding these companies and probably have developed detailed financial models on many of them.
Thus, launching a bond fund creates synergy as the bulk of the fundamental research has been completed. The firm mainly needs to hire a limited number of bond experts to convert the existing knowledge into investment insight specific for bonds.
Even though the gap between public and private equity is large, many of the sector fundamentals generated can be shared between the two business lines.
For example, assumptions of market rents and occupancy levels over the next several years form the basis of a REIT model.
The same set of assumptions can often help to identify desirable sectors for direct ownership.
Granted, some information can be sensitive, such as imminent real estate transactions by a listed vehicle, which is almost certainly non-public information, and a proper investment firm will need a competent compliance program to manage the information flow.
But the synergies generated from the market insights remain valuable.
Another synergy is the client base. Institutional investors often allocate their capital into bonds, equity, and alternatives, and all forms of real estate often fall under the same alternatives bucket.
This means that often a single team at an institutional investor will look after all these different asset classes, and thus, the investment managers can bring in opportunities from all four quadrants to the same investment team.
This is especially true with smaller institutions, such as mid-size family offices or small charity trusts. Given their size, these institutional investors can rarely develop a standalone real estate portfolio, if the theoretical guidance of fifty assets in multiple economies is to follow.
An investment manager can often tailor-make an investment program for these investors by combining all four forms of real estate to create a generally diversified portfolio.
The last synergy is that the four types of program are often suitable at different parts of a real estate cycle.
For example, we are in an interest rate upcycle currently. This means that long-dated, fixed-interest bonds (i.e., bonds with longer duration) will see pricing pressure as interest rates continue to go up.
However, REITs may see better performance because they generally see rental income growth during an interest rate upcycle.
Selected private debt can also perform because their tenure can be as short as two years, which allows investors to hold to maturity and renew their investment at the then prevailing interest rate. This effectively limits the interest rate increase risk.
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