Why invest in core-plus real estate?
With institutional investors searching for stable risk-adjusted return opportunities, core-plus real estate is a potentially attractive strategy that seeks to provide long-term income and capital appreciation potential. A diversifying complement to other portfolio holdings, core-plus real estate can also offer a degree of downside protection unmatched by mainstream financial assets.
Real estate can offer significant portfolio benefits
At a time when attractive risk-adjusted return opportunities are growing increasingly scarce, more investors are coming to appreciate the benefits that real estate can offer an investment portfolio. In addition to yield and long-term value creation potential, private real estate also has a history of complementing mainstream assets by demonstrating low correlation with public markets, long-run inflation hedging characteristics, and downside portfolio protection amid public market volatility.
Historical returns by asset class, 1997–2021
Source: Data for timberland refers to the NCREIF Timberland Index, December 31, 2021. Data for farmland refers to the NCREIF Farmland Index, December 31, 2021. Data for commercial real estate refers to the NCREIF Property Index, December 31, 2021. Data for small-cap equities refers to the Ibbotson series IA SBBI U.S. Small Stock TR USD, December 31, 2021. Data for non-U.S. equities refers to the MSCI EAFE International Equities Index, December 31, 2021. Data for corporate bonds refers to the Ibbotson series IA SBBI U.S. LT Corp TR USD, December 31, 2021. Data for U.S. Treasury bills refers to the Ibbotson series IA SBBI U.S. 30 Day Tbill TR USD, December 31, 2021. Data for the CPI refers to the U.S. Bureau of Labor Statistics, December 31, 2021. The S&P 500 Index series is from Standard & Poor’s Financial Services LLC, December 31, 2021. Data for U.S. private equity refers to the Cambridge Associates Private Equity Index, September 30, 2021. Data for U.S. forest products refers to the S&P Composite 1500 Paper and Forest Products series, December 31, 2021. It is not possible to invest directly in an index.
For institutional investors, choosing a real estate investment strategy isn’t a one-size-fits-all approach. While some strategies provide income, growth, or both, the risk/return spectrum is heavily dependent on market exposure, management expertise, and the use of leverage in each strategy; as such, it’s important to distinguish between what’s available in the market today. While the industry typically categorizes real estate into four main strategies, there isn’t a standard definition across all firms. We offer a general guideline.
Four main commercial real estate strategies in the market
Source: Manulife Investment Management, 2022. This is provided for illustrative purposes only and depicts the general risk/return profile of real estate investment styles. It can be expected that actual risk and return may vary from those shown.
Core |
This lower risk strategy focuses on income generation by investing in premium-quality assets that have high occupancy rates with high-quality tenants locked into long-term leases. The majority of expected return is likely to be generated through cash flow from owned properties. |
Core plus |
This strategy combines core assets and core-plus assets to create a balanced mix of risk and return. Core-plus assets, like core assets, generate income but their cash flow potential can be increased through moderate property enhancements, attracting higher-quality tenants, or better property management efficiencies. Once cash flow has been increased, the core-plus asset is often sold to capture the appreciation value. This strategy typically uses moderate leverage. |
Value add |
This strategy invests in properties that have the potential to produce significant cash flow after value has been added. While the total return potential is high, these properties come with greater risk due to more creative leasing and capital strategies required. This strategy typically requires greater level of leverage. |
Opportunistic |
This strategy follows a value-added approach, but further up the risk spectrum. These highly distressed properties typically carry a much higher level of leasing risk and require major capital expenditures or development of raw land. This type of investing requires higher levels of leverage, but could offer potentially higher return opportunities. |
Core plus can offer stable income plus capital appreciation potential
For those specifically looking for stable income in combination with growth potential, consider leaning into core-plus private real estate strategies.
Core-plus real estate strategies combine premium quality, high occupancy properties generating consistent and reliable income—core assets or stabilized assets—and slightly higher risk/return properties that may benefit from low to moderate capital improvements and/or improved leasing activity—core-plus assets or non-stabilized assets—into one investment portfolio. The flexible nature of this strategy can both complement and enhance real estate holdings by offering a balanced mix of risk and return through income generation and upside value creation.
The potential benefits of core-plus real estate
Constructing core-plus real estate portfolios
Although each core-plus investment strategy is unique, real estate investment managers build these portfolios by integrating the following to potentially enhance risk-adjusted returns:
- Maximizing value creation through active management of assets
Core-plus real estate strategies are made of up stabilized and non-stabilized assets. Whereas stabilized assets can provide consistent and reliable cash flow streams from lease payments, non-stabilized assets require enhancements to increase their cash flows. An asset that isn’t stabilized —either because occupancy is low, expenses are high, or amenities are outdated, for example—gives asset managers the opportunity to create value. Asset managers do this by undertaking analysis to understand how capital can be deployed for maximum asset price growth. Once an asset is stabilized, it can be sold to capture realized gains, and a new project is undertaken.
Asset managers with development capabilities can also choose to capitalize on build-to-core programs to develop value accretive projects from the ground up, and then hold the stabilized core asset for the long term.
- Investing in markets with strong growth characteristics
While real estate can be affected by the larger real estate cycle, sector and property performance can vary widely depending on factors such as demographics, economic growth, and supply-and-demand dynamics. As such, core-plus real estate strategies are typically diversified across markets, property sectors, tenants, and economic factors. This allows investment managers to continually find investable assets with strong income drivers at attractive price points throughout economic cycles.
- Active portfolio management with a boots-on-the-ground approach set competitors apart
Creating maximum value for investors often comes from combining a seasoned investment team with property management and leasing teams with extensive local experience. This boots-on-the-ground approach that engages and understands local markets to drive deal sources, in combination with deep expertise, can find and create unique opportunities to attract a diverse tenant mix, create efficiencies, and reduce operating expenses while enhancing cash flows and long-term returns.
Consider the risks involved
Although investing in real estate may offer numerous benefits, investors should also consider the inherent risk involved. While not all risks can be recognized ahead of time, those that can be identified are managed or minimized through diversification, active management, and other strategies.
Risk |
Mitigation strategy |
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Business conditions
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Demand for real estate depends on a variety of economic conditions: GDP, interest rates, inflation, employment, etc. |
Portfolio diversification and active management |
Demographics |
Demand for real estate depends on a variety of factors: size and age of the local population, rate of new household formations, etc. |
Diversification across markets, property sectors, and tenants |
Liquidity |
Real estate is considered illiquid due to the lack of ability to convert investments quickly into cash without a significant impact on price.
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Active management and disciplined risk management process |
Leverage |
Leverage can affect returns as funds for projects are often borrowed. Changes in interest rates and the ability to service loans are key things to consider.
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Active management and disciplined risk management process |
Environmental |
Real estate can be affected by environmental conditions, such as hurricanes, wildfires, floods, etc.
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Diversification across markets and property types, climate resilience management, and purchase of insurance protection
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Property management |
The risk lies in a property manager’s ability to oversee day-to-day operations, service tenants, reduce turnover, and create operating efficiencies.
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Leverage third-party providers who offer renowned services with well-defined risk management procedures in place
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No investment strategy or risk management technique can eliminate risk or guarantee returns in any market environment.
The obligation: delivering performance sustainably
While real estate offers the opportunity for long-term value creation and other portfolio benefits, with our planet facing one of its greatest challenges—climate change—real estate is increasingly doing this in a sustainable and responsible manner.
With buildings accounting for 40% of global carbon emissions, prioritizing sustainability has become a global effort. Green buildings and green building practices are environmentally friendly and resource efficient solution. They not only reduce negative impacts on the environment by using less energy, water, and natural resources, but they also create positive effects such as increased biodiversity and increased air quality.
As new construction guidelines continue to establish sustainable building practices, government subsidies reduce upfront cost, and more investors demand increased ESG practices, momentum will continue to build in the green building movement. In fact, across the globe the number of LEED-certified and registered projects—the mostly widely used green building rating system—has risen from 42 in 2000 to 100,000+ in 2019.
At Manulife Investment Management, our real estate portfolios reflect our commitment to a sustainable future. Sustainability is incorporated into every stage of the real estate value chain, and we’re committed to reinforcing our five sustainability commitments as detailed in our real estate sustainability framework.
Appetite for real assets is growing
As investors continue to search for income and growth, more are coming to appreciate how an allocation to private real estate can complement an investment portfolio. Core-plus real estate can offer an opportunity to invest in tangible assets where income generation and value creation are the ultimate goals.
Important disclosures
A widespread health crisis such as a global pandemic could cause substantial market volatility, exchange-trading suspensions and closures, and affect portfolio performance. For example, the novel coronavirus disease (COVID-19) has resulted in significant disruptions to global business activity. The impact of a health crisis and other epidemics and pandemics that may arise in the future, could affect the global economy in ways that cannot necessarily be foreseen at the present time. A health crisis may exacerbate other pre-existing political, social and economic risks. Any such impact could adversely affect the portfolio’s performance, resulting in losses to your investment
Investing involves risks, including the potential loss of principal. Financial markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments. These risks are magnified for investments made in emerging markets. Currency risk is the risk that fluctuations in exchange rates may adversely affect the value of a portfolio’s i