Opportunities & Obstacles for Private Real Estate (July 1, 2020)
Identifying Opportunities, Removing ObstaclesThe use of private real estate in defined contribution (DC) plans has continued to grow, though some challenges remain. Understanding and addressing these challenges is key to the continued acceptance of the asset class on the part of plan sponsors, consultants, and other gatekeepers.
Liquidity, for example, has often been raised as a concern. However, the vast majority of real estate products offer daily liquidity. Within custom target date funds or white labeled solutions, liquidity can be provided through hybrid vehicles that pair direct real estate with REITs and/or cash for liquidity purposes. A number of these products already have meaningful track records, and new entrants to the market offer more choice to plan sponsors.
But plan sponsors are not the only audience – there are typically multiple gatekeepers, especially for larger plans. These include investment advisors or consultants, human resources professionals, and glidepath managers, among others. For many of these groups, incorporating a new asset class isn't always at the top of their list of things to do. This inertia has been reinforced by ten+ years of strong equity markets, which has led to reduced demand for beta offerings and provided little reason for plan sponsors to further diversify the products available within their DC plans.
That, of course, changed dramatically with the tragic onset of the coronavirus. While the human cost of this illness has been terrible, it has inevitably taken a toll on the economy as well. When the crisis begins to recede, it will leave a changed landscape in many ways. In our sphere, we would expect that among many other considerations, plan sponsors will start to take a closer look at the potential role of alternative investment products, many of which provide current income, lower volatility and uncorrelated returns to the traditional stocks and bonds found in their plans. Research has shown that private real estate can help dampen volatility and improve investor outcomes, making it worthy of consideration in this evolving investment environment. The growing use of custom target date funds (TDFs) provides a logical vehicle for incorporating this asset class, and one that should be increasingly attractive to both plan sponsors and consultants.
Fees have been an issue with some plan sponsors as well, particularly as the core returns for the asset class have moderated over the past decade, but the industry has begun to address this, too. In general, fees have been trending downward, consistent with the broader investment management industry. Larger plans, which more often employ custom strategies, have the ability to spread costs over a larger asset base, lowering fees significantly in some cases.
Academic research has shown that Defined Benefit Plans that include alternative investments have consistently produced better outcomes, net of fees, than plans that do not have exposure to alternative investments. We are optimistic that plan sponsors will continue to see evidence of outperformance and lower volatility from plans that include private investments and adopt more alternatives within their investment regimes.
Direct real estate investing within the DC world is changing fast, but a full understanding of what that change means for plan sponsors and participants has often lagged the reality on the ground. While not yet mainstream, private real estate has been offered in DC plans for over 20 years, and we are now at a point where there is likely to be a significant reassessment of platforms, products, and plans that will include the role of alternatives such as direct real estate. The growing use of outside chief investment officers (OCIOs), a trend that has been building momentum, creates additional opportunities to advocate for the benefits of direct real estate.
Education has been and will continue to be the key as this process unfolds. This includes providing a rationale for owning private real estate – particularly for those plan sponsors with little or no experience with the asset class – and continuing to address issues of concern through research and dialogue with the DC community.