Investment overview: an introduction to real estate investing

June 24, 2024
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Investing in real estate is known for its potential, both in financial returns and in tangible, real world outcomes.

Although they are complex and require thorough vetting, they have demonstrated strong returns for knowledgeable investors. Now, individual investors can invest in real estate in various ways, including with platforms like Alto, as we work to facilitate access to this alternative asset so often associated with passive income.

Table of contents

In this overview, Alto covers…

The importance of real estate in the economy

Real estate involves property consisting of land and buildings. It also includes improvements made by previous owners or tenants, and the natural resources like water, minerals, plants, and animals included on the property.

The U.S. economy depends heavily on real estate as a generator of jobs and revenue. According to a report from Statista, this industry, including all related financing, insurance, and management, accounts for over 20% of the U.S. GDP.

Source: Statista

And that’s just the beginning.

The real estate sector’s impact on the economy (and daily life) cannot be overstated. Consider McDonald’s. Famous for burgers, nuggets, and even secret sauces, the brand’s balance sheet reveals an unexpected asset: over $40 billion in real estate holdings, more than 70% of their $56 billion in total assets.

Understanding commercial real estate investing, or CRE for short

The buying, selling, and investment of commercial-use property is widely known as commercial real estate. This sector entails property used for business purposes rather than as a living space, and it comes in many shapes and colors, including:

  • Retail space
  • Office buildings
  • Industrial properties (including manufacturing plants, warehouses, and mixed-use facilities)
  • Hospitality and entertainment venues
  • Sports complexes
  • Timberland and farmland
  • Data centersStorage (cold/dry)
  • Apartment buildings and complexes
  • Infrastructure

A dizzying array of options is just one part of the real estate investment puzzle, with CRE often being associated with income-generating potential.

And perhaps the best part? Real estate is a tangible asset investors can see and feel.

Traditional entry points for real estate investment

Investing in real estate is an alternative asset strategy that has long seen access determined, in no small part, by resources and wealth, which can play out in different ways for individuals and institutions.

Individual investors and bootstrapped deals

Investors can get into the real estate sector through transactions they can handle on their own or with a few service providers. This route can provide access to smaller scale investments, like home flipping (with incrementally larger and more complex residential properties being in the cards), storage spaces, trailer parks, and small retail spaces.

  • Outsized returns are possible. On the other hand, profits will also typically reflect the amount of “sweat equity” put into the investment.
  • Administrative overhead may be more easily navigable for smaller deals. However, laws continue to evolve, and individuals still must stay on top of their adherence.
  • Growth is often incremental. Slow growth can be sustainable, or it can be a hindrance, depending on an investor’s perspective and goals. The individual investor bootstrapping growth often involves one property of just slightly higher caliber replacing the one before.

If you want to dabble with the flippers’ route as an investor, then your entry point is somewhat clear: you may use personal capital, existing equity, or a loan from a retail or commercial bank to purchase and manage property.

Institutional investors, corporate development and real estate

You may know CRE for its high-caliber organizations, newsworthy transactions, and subsequent complexities. The teams involved in this flavor of real estate often take big risks in pursuit of big exits, and invest significant energy into analysis and valuation work in the hopes of mitigating risk to earn big profits. The large teams spread around the responsibilities, risks, and rewards of deals. They work hard to systemize the asset class’s transactions into an entire sector of the economy.

All this activity generates conversation and draws press coverage. Unfortunately though, institutional transactions rarely accept smaller capital commitments from individual investors who aren’t ultra high net worth individuals (UHNWI’s).

Where real estate fits into the alternative asset space

Private commercial real estate investments have many people and processes in place — and those often resemble the roles and their responsibilities involved in other alternatives.

Consider the people involved in private equity or venture capital. Private real estate deal teams can be similar. Principal stakeholders on a deal administer acquisitions, operate capital against an investment thesis, and aim for target returns that ideally beat public markets. Knowing the roles of some of these players in the broader private markets can help illuminate how  commercial real estate works, too.

  • General Partners (GPs): These are the professional investors initiating deals by organizing capital from LPs, assessing markets, and analyzing targets within those spaces for purchase.
  • Financial partners and capital parties: Coming in many different forms with different backgrounds, these are intermediaries who can offer additional expertise on market analysis, financing products, and capital allocation into deals.
  • Limited Partners (LPs): These are the wealthy investors who allocate large pools of capital, either their own, on behalf of institutions, or other individuals. They commit capital to GPs’ funds in exchange for a potential return.

There are additional similarities between real estate investing and the broader alternatives space. Private capital markets offer the potential for returns, and their market values are largely uncorrelated from public market investments. They also often share a variety of subcategories, like regional specificity (fine wine and rare spirits), transaction sizes by firm strategy (private equity and venture capital), and more.

While consistencies abound, so do unique considerations for investors considering investing in real estate. Envision the unique hazard of unpredictable weather forces that can take investors by surprise, leveling buildings and disrupting their onsite operations in a single day. On the other hand, imagine the unique ways real estate investing stands out in beneficial returns and disbursements: depending on your investment strategy, it has the potential to produce regular cash flow from rent payments.

Investing in real estate for long-term portfolio diversification

Protecting your investments is perhaps as important as growing them. That’s why it can be a good idea to spread the downside risk of a portfolio across multiple asset classes.

Historically, this has meant a 60/40 split of stocks and bonds, keeping most individuals heavily invested in public markets because of the limited availability of alternatives. But public markets are not insulated from risk. While they are a great place to start building a portfolio, just like every basket, you shouldn’t keep all your financial hopes in one place.

Investing into alternative assets can provide portfolio diversification that can boost returns and mitigate risk from public market downturns and other macroeconomic factors, like inflation.

A 2024 report from JP Morgan revealed that just a 25% allocation in alts can improve 60/40 returns by 60 basis points — an 8.5% improvement over the long-established 7% expectation.

Source: U.S. Bureau of Labor Statistics via St. Louis Fed

For example, real assets have provided protection against the diminishing purchasing power of the U.S. dollar. Since the Federal Reserve’s inception just 100 years ago, the US dollar has lost 95% of its purchasing power, with a notable decline in the past eight years alone.

When external pressures weaken the dollar, it loses value, reducing purchasing power as goods and services become more expensive, which in turn negatively impacts public markets.

Contrast that picture with the value of commercial real estate. Its average has only increased according to research from Statista, even amid recessions and inflationary periods.

Source: Statista

As publicly traded equities experience value fluctuations, real estate remains mostly untethered from those changes. In this way, real assets effectively hedge against pressure weakening the dollar. In contrast, during times of high interest rates, real estate investments could become subject to defaults and generally increased risk.

In the book Wiser Investing, Casey Frazier, CFA, CIO of Versus Capital Advisors, says that the rising popularity of CRE among retail investors is an inevitable and a necessary development. “Real assets have been a primary source of wealth accumulation and preservation for more than five thousand years, but until recently, they have not been available to the average investor,” he says. “These investments should have a long-term, foundational position in every investor’s portfolio.”

“Real assets have been a primary source of wealth accumulation and preservation for more than five thousand years, but until recently, they have not been available to the average investor. These investments should have a long-term, foundational position in every investor’s portfolio.”

Casey Frazier, CFA, CIO,
Versus Capital Advisors

How individuals are overcoming barriers to investing in real estate

Technology and service providers like Alto are building issuer and intermediary relationships, standardizing operating processes, and offering those procedures as a useful way to invest in real estate. Many individual investors may not have had this access before, or known about it if they did.

How? One way is by organizing feeder funds to funnel private capital into master funds of trusted general partners. A feeder fund (or more simply, “feeder”) is an investment vehicle consisting of the smaller contributions of dozens, hundreds, or even sometimes thousands of individual investors. Representing these individuals is an administrator who knows the market and can connect with GPs with significant experience in a given field of alternative investing.

Another way is for individual investors to take their capital to their RIA or wealth manager, who offer up publicly traded REITs as an option. Since the companies represented in public REITs trade on registered exchanges like other general equities, they’re not quite a diversified asset, reducing the purpose of real estate investing for diversification.

The good news is that individuals are finding facilitators that create and manage ways to participate in sponsor-led CRE opportunities.

Alto is an example of this kind of facilitator and advocate, acting as custodian for investors and their real estate investments into numerous opportunities offered by Alto partners.

Still, research conducted for 2024 revealed that the most significant barrier to investing in alternative assets like CRE remains a lack of familiarity and understanding, even as investing in real estate surfaced as a most interesting strategic asset class. Alto and its partners recognize this and will continue to educate and pave the way for individual investors to access alternatives like real estate.

Three upsides to committing retirement funds to real estate

Alto gives individuals access to alternatives including investing into real estate with one particularly key upside: the option to use retirement funds to fund an investment. Those retirement funds (and the investment strategies behind them) typically align with the characteristics of real estate in key ways:

  • Longer time horizon: The nature of commercial real estate is known for buy-and-hold expectations, which align with more strategic savers who recognize these assets are highly illiquid and difficult to divest.
  • Historically resilient: Assets like real estate offer potential insulation from public market risk.
  • Tax benefits: Retirement funds are tax-advantaged, and real estate investments also enjoy certain tax breaks, appealing to investors who look for ways to keep as much of their earnings from an investment as possible.

The alignment of the longer-term time horizon naturally present in both retirement funds and alternative assets provides investors a strategy that we refer to as duration matching.

What investors might expect in the evolving real estate space

One of the considerations investors can weigh is how the real estate market is evolving in the immediate future. Here’s what experts foresee today.

  • More value: As previously mentioned, real estate investing goes far beyond the most obvious choices of homes, offices, and retail space. So even if those sectors lose market value, other sectors, such as infrastructure and farmland are increasing in value at a greater rate. That’s why, based on a variety of factors including past performance and current economic forces, data from Statistica indicates steady value growth for private real estate as a whole.

Source: Statista

  • More participants: Individual investors will likely increase in sophistication and capability, becoming more able to partner with issuers and evaluate deals. In a 2023 survey of advisors to retail investors done by iCapital, 50% said that their clients’ interest in alts has increased over the last two years. And the increase of retail capital into the CRE space was listed in second place as Institutional Real Estate, Inc.’s top five megatrends of 2024.
  • More changes: Investors can also expect market and economic factors to continue impacting CRE deals. Regions may surprise everyone by experiencing either a real estate renaissance or dismissal. For example, while San Francisco and New York City have been well-known tech hubs, new capital and talent are flooding into areas like Vancouver, Austin, and Raleigh-Durham. Real estate development opportunities and the necessary capital to support them seem a likely outcome of modern mass migration.

    GPs that monitor financing  trends will likely have an advantage in winning bids over those who miss important developments. For example, debt and private credit is all the rage today, but in the coming months, experts in commercial real estate at CBRE are predicting that all-cash investment groups will face fewer competitors.

    One way individuals can stay privy to news that will impact their potential CRE investing strategies is to ask how every major headline will change “business as usual.” For example, some investors who saw the tangled supply chains of 2021 and 2022 invested in logistics and infrastructure, a move that’s already proving fruitful. Others saw the enduring nature of cook-from-home trends and invested in cold storage.

Investing in real estate offers can offer the benefits of portfolio diversification

Diversified portfolios are for more than simply hedging against risk: they have outperformed traditional allocation strategies in the past. Alto believes that the term “diversification” itself can be broadened past the traditional definition of a 60/40 portfolio of stocks and bonds. True diversification can extend further to include alternative assets that have long been more difficult to access, and real estate is one such sector.

Amidst a retailization wave within alternative assets, Alto offers multiple ways for investors to access them. Federal regulators have said that the percentage of global investable capital allocated to private assets has gone from 2% to 7% in 20 years, a pace twice as fast as public market growth. That growth curve includes real estate, and the sector is ripe for consideration by individuals seeking the benefits of diversification into alternative assets.

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