Economy
In an article for MarketWatch, Brett Arends discusses the tradeoffs of traditional real estate investing vs REITs. While many people have built wealth by buying and renting homes, Arends believes that investing in REITs is a better option for most investors given costs and complications.
Additionally, the upside of real estate ownership is less appealing in an environment of higher borrowing costs. Many real estate investors are making the mistake of looking at returns over the past 30 years and projecting them forward. However, the last 30 years saw interest rates decline by a significant margin which is unlikely to be true over the next 30 years.
REITs offer exposure to real estate as well and have outperformed home prices by about 3% annually. Currently, home prices remain elevated, while REITs are down 40% over the past year in many cases, leading to attractive yields and compelling value.
Further, REITs are much more liquid and can be bought and sold instantly through any brokerage. In contrast, real estate transactions have massive costs and take time. Additionally, REITs are inherently more diversified than a real estate investment which means less risk.
Finsum: Brett Arends discusses why the risk-reward equation currently favors REITs over traditional real estate investing given costs, value, and complexity.
In an article for SeekingAlpha, Armada ETF Advisors make the case for why public real estate is due to outperform vs private real estate given the gap in valuations. Over the last couple of years, the combination of the Fed’s rate hiking campaign and weakness in segments of the real estate market like commercial real estate have led to major drawdowns for publicly traded REITs.
In contrast, private real estate has fared much better. According to Armada, these types of wide differentials in performance have been reliable indicators of mean reversion, historically. In addition to favorable valuations, the firm also believes that the headwind of higher rates is about to recede given trends in inflation and budding signs that a recession is imminent.
Over the last 2 decades, there have been 8 instances when REITs underperformed by more than 10%. Each instance was followed by a period of strong REIT performance in absolute and relative terms.
It’s also a rare opportunity for investors to acquire high-quality real estate assets at cheaper prices than what is available in private markets. Typically, the situation is inverted given the greater liquidity of publicly traded REITs.
Finsum: Private real estate has outperformed public real estate by a significant amount over the past year. But, it could be an indication that a major mean reversion is imminent.
Two of the most common ways to invest in real estate are through REITs or private real estate. While both have similarities, there are some key differences in terms of structure, liquidity, access, risk, and return.
REITs are similar to mutual funds in how they are traded and valued. However, they must derive 75% of their income from real estate investments and distribute 90% of taxable income to shareholders. There are a variety of REITs that encompass the whole industry such as retail, commercial real estate, senior housing, multifamily, office, etc.
Unlike private real estate, there is no end date, and they can operate in perpetuity. Private real estate differs from REITs in that they tend to be pooled investment vehicles that give investors fractional ownership.
While REITs must abide by strict tax laws, there is no similar requirement for private real estate. Another difference is that private real estate tends to not offer income. Instead, their goal is to pool capital to acquire and develop a property, hold it for seven to ten years, sell it at a profit, and return proceeds to investors with the operators taking a cut.
Finsum: There are many ways to invest in real estate. Two of the most common are REITs and private real estate. Here are some key differences between both options.
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In a CNBC interview with Sara Eisen, Goldman Sachs CEO David Solomon warned that there was more pain ahead for commercial real estate. The bank is marking down its holdings as the sector faces a torrent of headwinds.
The most notable include the rise of remote and hybrid work which is structurally reducing demand for office space. E-commerce continues to take a greater share of spending which is affecting retailers with physical locations. Finally, higher rates have also added to the industry’s woes as many owners are defaulting on properties rather than refinancing loans.
Due to this, the bank is posting impairments on its loan book and equity holdings which will impact its upcoming results. In the first quarter, the bank wrote off nearly $400 million in real estate loans. Solomon believes that other banks will also be making similar moves.
However, Solomon sees the challenge as being manageable and not significant enough to thwart Goldman’s overall business. But for smaller banks, it could be a bigger problem since they tend to be more heavily exposed to commercial real estate.
Finsum: Commercial real estate is facing a tough time due to higher rates and reduced demand for office space. In an interview, Goldman Sachs CEO David Solomon shared how the bank is dealing with the challenge.
Over the last year, Elon Musk has been increasingly pessimistic about the US economy and warning that a more severe downturn is coming. Recently, he warned that the prospects of commercial real estate would suffer due to a lack of financing given stresses in the banking system, and workers who are not returning to offices. In an article for TheStreet, Luc Olinga covers Musk’s thoughts on the matter.
Now, the Tesla founder and CEO is also warning that the residential real estate market could face similar pain as inflation and a weakening economy mean that demand will be tempered, while supply is artificially constrained as homeowners with low mortgage rates are unwilling to sell.
He sees the same underlying factor negatively impacting residential real estate and commercial real estate - banks raising their lending standards which curtails demand. This would lead many prospective buyers to fail to qualify for a mortgage.
On top of this, there are a myriad of other economic stresses such as inflation and higher rates leading to higher costs and payments. At the same time, Musk sees it as inevitable that the labor market experiences its own downturn, adding to pain for the US economy and housing market.
Finsum: Elon Musk has been quite vocal in warning about risks to the economic outlook. He recently shared why he thinks residential real estate could follow commercial real estate lower.
All asset managers are adapting to this macro environment in their own ways. In terms of private real estate, funds are taking more time to make investment decisions, exploring new sources of financing, and structuring creative methods to deploy capital. Jenn Elliot covered the cautious behavior among private real estate funds for WealthManagement.
It’s a sharp turn from the last couple of years when funds were much more aggressive in terms of investing and raising capital. Now, raising capital has become much more difficult given that the risk-free rate of return is above 5%. Additionally, rising recession risk, stumbles in the banking system, and stress in commercial real estate have also muddied the picture.
One silver lining is that many investors have been sidelined which means there is less competition for deals. Thus, private real estate funds have more time to evaluate ideas and can be more selective.
However, the most significant headwind is that a deflationary mindset has become pervasive. Essentially, most investors expect that prices will decline over the next year. In some ways, this becomes a self-fulfilling prophecy. So far, damage has been contained to commercial real estate where there have been a few high-profile defaults and redemption requests.
Finsum: Private real estate funds are behaving much more cautiously due to higher rates and increasing economic uncertainty.