The return left on the table: why real estate deserves one lens, not four

Strategic asset allocation has served institutional investors well. The discipline that comes with clear buckets, clear mandates, and clear accountability has allowed institutional investors to make large pools of capital governable. Nothing about that discipline is the problem. The question worth asking is narrower and more practical: within the real estate asset class, is looking at public, private, debt and equity exposures separately across different allocations costing returns that a more holistic view would capture?

Uma Moriarity is senior investment strategist at CenterSquare Investment Management

Real estate can be accessed via public and private markets and across the capital stack through debt and equity investments. However, it is still just the same asset class trading in different wrappers. They are all pricing exposure to the same buildings, the same tenants, the same rents.

However, most institutions allocate to the asset class through separate lines: a private real estate mandate siloed from a listed real estate mandate that might fit into listed equities or a real estate debt mandate that might fight into credit.

And all these allocations are run by different teams, benchmarked against different indices. That structure works well for governance. It is less-well suited to capturing what happens when those wrappers price the same underlying property differently at the same moment, which, in real estate, happens often and persistently.

\Time and again, listed real estate moves ahead of the private real estate markets. Look at what happened as rates rose and then plateaued. Listed real estate, which trades every second on public exchanges, is repriced almost immediately. European REITs, as measured by the FTSE EPRA Nareit Developed Europe Total Return Index, peaked in 2021 and prices fell about 50% by the third quarter of 2022, though they have recovered 54% since that trough. 

Private real estate funds, valued periodically by appraisers rather than continuously by the market, took longer to catch up. The European funds in NCREIF’s Global Real Estate Fund Index (GREFI) did not print negative returns as a function of this debt-driven repricing until the second quarter of 2022, when the REITs were nearly bottoming.

An investor holding both exposures, with a mandate that could move between them, had the option to lean into the beaten-down listed sleeve while it was cheap and let the private book re-rate on its own timeline. Few portfolios are built to do that today, simply because the public and private pieces usually sit with different teams, different benchmarks, and different review cycles.

That gap between public and private pricing is not a secret. It shows up in REIT pricing every minute of every day.

It shows up in the spread between appraisal cap rates and the cap rates where deals are transacting. It is a persistent, observable feature of how real estate is priced across markets. The investors best positioned to act on it are the ones whose real estate exposure is viewed and managed as a single spectrum, rather than as several separate line items across different allocations.

The same logic applies across the capital stack. An investor holding only private equity real estate carries the property’s full upside but also its full downside with limited ability to materially move down the risk profile.

A separate allocation to real estate debt, elsewhere in the portfolio, is exposed to many of the same underlying assets with structurally more protection and a different return driver of income rather than appreciation. 

Viewing debt and equity, public and private as points on one continuum, rather than as distinct allocations, offers a wider range of opportunities to capture return and manage risk than any single point on that continuum offers on its own.

This is close to the thinking behind the total portfolio approach that a number of large asset owners globally, like Australia’s Future Fund and Canada’s CPPIB, have applied at the whole-fund level. And a growing number of European pension funds and insurers are now exploring this concept for individual asset classes.

Real estate may be the most natural place to start, precisely because it already trades across genuinely distinct wrappers with genuinely different liquidity and valuation mechanics.

That is exactly what creates the pricing gaps, and exactly what a mandate built to move across public and private, debt and equity, is designed to capture. 

Uma Moriarity is senior investment strategist at CenterSquare Investment Management