Real estate diversification that isn’t listed REITs
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Managing director Rick Schaupp discusses veteran leader in private real estate Clarion Partners’ investment strategy and new partnership
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INSTITUTIONAL INVESTORS have long used private real estate in an effort to generate steady income and asset appreciation. But given the market dynamics of recent years and quest for yield, retail investors have been joining institutional investors in increasingly using private commercial real estate (CRE) to potentially hedge against inflation and diversify.
The pandemic ushered in a new wave of volatility and unpredictability in the industry, with central bank policies raising interest rates, creating challenges in the near-term. But Richard Schaupp, managing director at Clarion Partners, points out that there are still many compelling opportunities.
Franklin Resources, Inc. [NYSE:BEN] is a global investment management organization with subsidiaries operating as Franklin Templeton and serving clients in over 155 countries. In Canada, the company’s subsidiary is Franklin Templeton Investments Corp., which operates as Franklin Templeton Canada. Franklin Templeton’s mission is to help clients achieve better outcomes through investment management expertise, wealth management, and technology solutions. Through its specialist investment managers, the company offers boutique specialization on a global scale, bringing extensive capabilities in equity, fixed income, multi-asset solutions and alternatives. With more than 1,300 investment professionals, and offices in major financial markets around the world, the California-based company has over 75 years of investment experience and approximately US$1.4 trillion (approximately CDN$1.9 trillion) in assets under management as of August 31, 2023.
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Hypothetical 10-year old portfolio return with and without private equity real estate
Without Real Estate
“Private real estate can serve as a strategic addition to investment portfolios”
Rick Schaupp,
Clarion Partners
Clarion stands as one of the largest pure-play real estate investment managers in the US, overseeing $80 billion in assets and boasting a portfolio of approximately 1,500 properties. The firm’s legacy lies in managing individual accounts and commingled funds for substantial pension operators, sovereign wealth funds, and other institutional investors. Its private real estate income strategy came about a few years ago when the firm began looking at how to diversify its investor base.
Franklin Templeton’s investment in Clarion three years ago opened the door to helping the firm reach that new base. Franklin Templeton is one of the largest global investment managers, with offices all over the US and world. The alternatives team at Franklin Templeton has broadened its investment offerings to bring Clarion’s historically institutional platform to individual investors, some of whom are fairly new to real estate investment. This expansion is a testament to the organization’s commitment to adapt Clarion’s extensive institutional expertise to cater to a diverse range of investors.
Schaupp maintained, “We aimed to collaborate with a partner like Franklin Templeton, known for its deep relationships within the private wealth space. Gaining access to this investor demographic was pivotal for the successful launch of this strategy.”
Schaupp's confidence in Clarion's investment strategy remains unshaken. He asserts, “Our strategy is well-positioned today and allows us to take advantage of the opportunities that we see. The real estate income strategy
Yet Schaupp believes that it’s essential to remember that not all properties, sectors, and markets are the same. Instead, he’s zeroing in on sectors and locations where Clarion believes fundamentals remain strong, like industrial warehouses and multi-family housing in high-demand areas.
Moreover, Schaupp emphasizes the overarching benefits of private real estate. He notes, “Private real estate can serve as a strategic addition to investment portfolios. Historically, private real estate showcases low correlations to stocks and bonds, and lower volatility than stocks, bonds, and publicly traded REITs, offering strong income and overall returns.” For investors seeking diversification, certain real estate sectors can also offer stronger risk-adjusted returns than a traditional 60/40 stock and bond portfolio.
By comparing private real estate strategies to publicly traded REITs, one can discern their distinctive advantages. For example, REITs are heavily influenced by market sentiment with a volatility profile typically higher than private real estate, which takes an appraisal approach to valuing direct property investments that is more directly derived from real estate fundamentals. Unlike public entities, private real estate firms share data with independent appraisers who conduct thorough valuations, resulting in less susceptibility to market movement.
Of the process, Schaupp says, “We utilize an external appraiser to assess the value of each asset every month. Once these valuations are confirmed, they are reflected in the share price immediately. We then pass a daily share price through to our investors by accruing for income daily.”
Commercial real estate’s value is largely dictated by its purpose. For example, demand for traditional office space is slowing as companies reconsider their needs in a changing work environment. Despite current repricing of office assets, Clarion has been underweight in the office sector for over a decade. At the same time e-commerce growth and
onshoring, which is being driven by a trend toward local manufacturing and changes in sourcing post-pandemic, have amplified the need for warehouses. While underweight office for the past decade, Clarion has been overweight industrial over the same time period.
The US housing shortage, coupled with millennials and Gen Z reaching pivotal life milestones, boosts the rental housing market. Similarly, necessity retail, including major grocery chains and discount stores, remains robust, despite the decline in malls. These trends, when evaluated through a local demographic and economic lens, may offer potential for growth.
However, Schaupp acknowledges the immediate repercussions rising interest rates are having on the real estate industry. As financing has become more expensive, property values have started to adjust. Schaupp says, “Values have begun to reflect the higher interest rate environment, and expected investment yields have risen, notably in areas like multi-family housing.”
Despite all of these challenges, Clarion Partners believes that investors should remain patient. Private real estate cash flows are connected to long-term lease contracts and, as such, Clarion believes in the durability of the income stream over time, especially for sectors where fundamentals remain favorable.
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Published 27 November 2023
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“The real estate income strategy is invested in sectors that have strong fundamentals such as multifamily housing, industrial warehouse, and life sciences”
Rick Schaupp,
Clarion Partners
Adding real estate can improve returns and lower risk
Return
8.50%
Risk
8.55%
Return Per Unit Risk
0.99%
40%
Bond
60%
Stock
With 10% Real Estate
Return
8.71%
Risk
7.33%
Return Per Unit Risk
1.19%
35%
Bond
55%
Stock
10%
Real Estate
Adding 10% private real estate has historically improved risk adjusted return by more than 20%
Source: Clarion Partners Investment Research, NCREIF, Bloomberg, REIT.com, 2Q2023
Note: Private Equity Real Estate Index = NFI-ODCCE is used as a performance benchmark for core real estate (stabilized institutional quality assets). S&P 500 is one of the best presentations of the U.S. stock market. Bloomberg US Aggregate Bond index is used to represeent investment-grade bonds being traded in the United States.
Risk is measured using standard deviation of annual total returns. Past performance is not indicative of futurre results, anda risk of loss exists. Index returns do not include managements fees or related fees.
Additionally, there’s potential for private real estate investments to appreciate in value by blending durable income with potential capital growth if one invests directly in high-quality, well-leased properties in sectors with compelling supply/demand dynamics.
Schaupp is enthusiastic about the private real estate income opportunities Clarion Partners and others are now offering individual investors, allowing for direct exposure to a real estate portfolio and engagement with institutional-level advisors. Clarion’s aim is to offer investors the advantages that institutions have enjoyed from core real estate over Clarion’s 40-year history in a straightforward and transparent structure.
Breaking down private CRE strategy
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As of September 30, 2023
Disclaimer
This material is intended to be of general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell, or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice. This material may not be reproduced, distributed or published without prior written permission from Franklin Templeton.
The views expressed are those of the investment manager and the comments, opinions and analyses are rendered as at publication date and may change without notice. The underlying assumptions and these views are subject to change based on market and other conditions and may differ from other portfolio managers or of the firm as a whole. The information provided in this material is not intended as a complete analysis of every material fact regarding any country, region or market. There is no assurance that any prediction, projection or forecast on the economy, stock market, bond market or the economic trends of the markets will be realized. The value of investments and the income from them can go down as well as up and you may not get back the full amount that you invested. Past performance is not necessarily indicative nor a guarantee of future performance.
All investments involve risks, including the possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested.
The risks associated with a real estate strategy include, but are not limited to various risks inherent in the ownership of real estate property, such as fluctuations in lease occupancy rates and operating expenses, variations in rental schedules, which in turn may be adversely affected by general and local economic conditions, the supply and demand for real estate properties, zoning laws, rent control laws, real property taxes, the availability and costs of financing, environmental laws, and uninsured losses (generally from catastrophic events such as earthquakes, floods and wars). Diversification does not guarantee a profit or protect against a loss.
Investments in alternative investment strategies are complex and speculative investments, entail significant risk and should not be considered a complete investment program. Depending on the product invested in, an investment in alternative investments may provide for only limited liquidity and is suitable only for persons who can afford to lose the entire amount of their investment.
Any companies and/or case studies referenced herein are used solely for illustrative purposes; any investment may or may not be currently held by any portfolio advised by Franklin Templeton. The information provided is not a recommendation or individual investment advice for any particular security, strategy, or investment product and is not an indication of the trading intent of any Franklin Templeton managed portfolio.
Any research and analysis contained in this material has been procured by Franklin Templeton for its own purposes and may be acted upon in that connection and, as such, is provided to you incidentally. Data from third party sources may have been used in the preparation of this material and Franklin Templeton ("FT") has not independently verified, validated or audited such data. Although information has been obtained from sources that Franklin Templeton believes to be reliable, no guarantee can be given as to its accuracy and such information may be incomplete or condensed and may be subject to change at any time without notice. The mention of any individual securities should neither constitute nor be construed as a recommendation to purchase, hold or sell any securities, and the information provided regarding such individual securities (if any) is not a sufficient basis upon which to make an investment decision. FT accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user.
Products, services and information may not be available in all jurisdictions and are offered outside the U.S. by other FT affiliates and/or their distributors as local laws and regulation permits. Please consult your own financial professional or Franklin Templeton institutional contact for further information on availability of products and services in your jurisdiction.
Clarion Partners, LLC is a Franklin Templeton company.
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is invested in sectors that have strong fundamentals, such as multifamily housing, industrial warehouse, and life sciences. Additionally, our use of low leverage and ability to invest in private real estate debt has allowed us to take advantage of opportunities in the current market environment.”
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Copyright © 1996-2023 KM Business Information Canada Ltd.