Advisors who want to take full advantage of the real estate sector are going to have to do it with a combination of exchange-traded public real estate investment trusts (REITs) and private real estate funds, according to a report issued by J.P. Morgan Asset Management’s Strategic Investment Advisory Group.

Over the years, the investable real estate market has expanded beyond the traditional sectors of offices, retail space, residences and industrial facilities to also include self-storage, healthcare facilities, data centers and telecommunications sites. However, access to those sectors has been inconsistent between REITs and private funds.

REITs have a more balanced approach to investing in both the traditional and expanded sectors, with half of their investments in each, according to Pulkit Sharma, head of alternatives investment strategy and solutions at J.P. Morgan Asset Management. The private funds are more unbalanced, with 90% of those investments dedicated to traditional core real estate, Sharma explained.

The J.P. Morgan report, called “The Role of Public and Private Strategies in Real Estate,” found that while REITs and private real estate funds share similar underlying investments, their structures are vastly different in terms of sector exposures, return and risk targets, price volatility, leverage and liquidity.

However, advisors do not need to select one or the other, since both are integral to a balanced portfolio, Sharma said in an interview with Financial Advisor.

“We believe public REITs should serve as a complement to private real estate, not as a substitute for it,” he said. “Portfolios spanning public and private market real estate exposures may improve the risk and return trade-offs for investors, offer them access to a fuller spectrum of sectors and provide more tactical flexibility—ultimately leading to a better level of long-term performance and diversification.”

REITs Are Lagging In 2024
REITs in general have been down this year, with the FTSE NAREIT All Equity REITs index, which measures the performance of U.S. listed REITs, down 1.3% as of April, according to the National Association of Real Estate Investment Trusts. Real estate is still the only S&P 500 sector that is down year to date, while the market-value-weighted S&P 500 is up 10.6% and the equal-weight S&P 500 has risen 7.9%. 

However, over the past 10 years the professionally managed global real estate market has doubled, to $13.3 trillion, based on numbers from the MSCI, according to J.P. Morgan’s report.

When it comes to real estate investments, office space is a topic that comes up a lot. It is a sector that has undergone its own share of upheavals in the past few years, yet it’s still a viable investment, according to Sharma. Many private funds invest about 20% of their overall allocations to office space while REITs invest only about 5%.

While many companies have been returning to the office, they have not necessarily been coming back to their original buildings. Companies have been looking to reduce their footprint and are building newer offices, but at a higher quality than their previous ones, according to Jared Gross, head of institutional portfolio strategy at J.P. Morgan Asset Management.

“That has made newer well-located properties trade at a premium while less-well-located properties, where they maybe previously had a lot of square footage, have been suffering,” Gross said in an interview.

Another factor offices have had to contend with is higher interest rates, particularly when it comes time to refinance their mortgages. The offices that are underutilized have felt the pinch a little more, he explained.

“As these properties come up for refinancing, those that are fully occupied ... they’re not having any challenges financing themselves,” he said. “For those that are not fully occupied and don’t have as much revenue and then also have to be refinanced at a higher interest rate, that’s where the stress is concentrated.”

Be Strategic, Don't Abandon
For advisors looking to increase their real estate allocation, Gross reminded them to see the investment from a strategic perspective rather than a tactical one. He cautioned investors not to abandon the asset class whenever there’s negative publicity. 

He suggested that advisors choose a large diversified real estate strategy that is actively managed and finds properties with quality underwriting. The strategy should also be thoughtfully and tactically allocated across sectors, Gross said.

“I think the diversification that you can get within real estate and the ability of diversified real estate funds to provide exposure to multiple sectors and to move dynamically across sectors over time is, for most investors, the right way to approach the asset class,” he said.

Meanwhile, Sharma suggested that when advisors build a portfolio, its foundation should consist of high-quality income-producing products within the public and private space. Satellite investments should then be built around those.

“As a principle,” Gross said, “it’s the diversification and the tactical flexibility that will ultimately lead to the best outcomes. And the quest for the advisor is finding the best vehicle for their particular client.”