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Relying on Private Real Estate's Income Component as a Means of Retirement Security

By: Sabrina Unger, American Realty Advisors 

For individuals planning for a secure retirement, resiliency and stability of the asset classes their funds are invested in is critical. This article explores how plan investments in real estate can assist in providing security of routine income to pension participants by virtue of cash-flowing, stable property leases.   
This is an excerpt from NCPERS Fall 2024 issue of PERSist.

For individuals planning for a secure retirement, resiliency and stability of the asset classes their funds are invested in is critical. In this context, private real estate stands out as a critical solution in retirement plans' broader asset allocations (yes, even in today's more volatile environment) given real estate's generally stable income component.  
 
More income, more stability.  
Income represents roughly 80% of private real estate total returns, as property leases offer reliable and regular cash flows that form the bulk of performance. This compares favorably against other risk assets like public REITs and stocks, where income is a lesser share of the total return investors can achieve (Figure 1, left-hand side).  

Having income as the primary performance driver also reduces volatility, which is critical to offering a smooth ride in retirement. Appreciation, which refers to the increase in value of an asset over time, tends to be inherently a more volatile part of total returns because it can be influenced by broader capital markets shifts (like for instance, a rapid rise in interest rates) that prompt big changes in perceived value. In fact, we can see that, while appreciation accounts for roughly 20% of private real estate's total returns, it is responsible for more than 80% of its volatility! (Figure 1, right-hand side).  



What is income and appreciation, really?

What does this have to do with creating resiliency in your retirement plan? Perhaps this is best explained with an example.  

Imagine you buy a house as an investment. You rent it out to a young family; they pay you $2,800 a month. This fixed, predictable payment is your income return, and one you can, with some degree of confidence, rely on. 

Meanwhile, you hold on to that house for 10 years. In one year, three houses on your street sell for more than what you purchased your house for; the appreciation (the increase in value) is good. The next year, the Fed raises interest rates, making it a little harder for some people to afford to buy homes, and so prices stay relatively flat – your appreciation could be zero or even slightly negative that year. Though the cash flow coming off your home from your renters hasn't changed, and you're still receiving it every month, appreciation from year to year could vary a lot.  

The reinforced role of real estate income in today's retirement portfolio. 

The last four years have represented a period of elevated volatility for investors to navigate relative to the decade-plus preceding them, made all the more challenging by the need to interpret the effects of a pandemic, high inflation, policy pivots, and rapidly rising interest rates on the different asset classes in their portfolio.  

Real estate on the whole has not been immune to some of the downside stemming from these forces. Total returns for the NCREIF Property Index (an index that tracks unlevered property-level investment performance or returns without the impact of debt) in 2023 were negative at -7.61%, with open-end diversified core funds (represented by the NCREIF ODCE index) posting a -12% return (adversely impacted by leverage effects). Given this, does the case for maintaining exposure to private real estate as a mechanism for protecting your income in retirement still hold?  

In our view, the answer is yes. Despite recent headline returns, that resilient income component is still holding up against drags from the broader capital markets repricing of assets, as seen in the dark blue column in Figure 2.  

 

As was the case in our house example, it's the implied value of the home that oscillates depending on whether somebody sold down the street for a loss (they had no choice but to sell at today's prices to move closer to family) or whether nothing has sold at all (all the neighbors are waiting for the market to improve); all the while, the rent keeps being paid.  
 
Bio: Sabrina Unger, Managing Director, is the Head of Research & Strategy at American Realty Advisors and is responsible for leading the firm's research initiatives and working closely with the firm's Investment and Portfolio Management teams in developing investment analysis in support of new acquisitions and strategy implementation.  

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