Why real estate needs to be considered as more than one asset class

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There’s an old adage that “location, location, location” should drive real estate investment decisions. And while that’s largely true, diversification is also key across segments of the sector such as commercial, industrial, office and multi-family assets. Increasingly, advisors are looking at private real estate to diversify client portfolios, especially during challenging economic times.

“Real estate also serves as a nice counterbalance to the volatility and emotion experienced by the public markets,” says Mark Hannah, managing director of Nicola Wealth Real Estate, a division of Vancouver-based Nicola Wealth Management Ltd., which owns a range of private real estate across North America.

Too often, investors lump real estate together as one asset class, which Mr. Hannah says could mean missing opportunities and overlooking risk.

“You can’t just look at real estate in general; you need to break down each sector and examine how different assets and geographic markets perform in normal and stressed environments,” he says. “Fund composition matters in a stressed environment so that you have a diversity of the right asset types and geography to help weather the storm.”

Globe Advisor spoke with Mr. Hannah recently about how the rising interest rate environment has affected private real estate and his outlook for the sector:

How has the current economic environment affected the sector?

Most experienced real estate players knew the low interest rate environment wasn’t sustainable and it was only a matter of time before interest rates would start to rise. Our team was preparing for this moment and fully anticipated that property valuations would be affected as a result of higher interest rates.

That said, we haven’t seen any significant movement in valuations in certain segments such as industrial, self-storage and apartment buildings. Smaller retail assets are also doing relatively well, as are hotels, as people travelling again after being couped up due to the pandemic lockdowns. Segments that we expect to be most affected in the current environment include high-rise office towers, with fewer people returning to the office, and possibly enclosed shopping malls, with the rapid expansion of e-commerce coming out of the pandemic and people spending less to be more cautious.

These impacts are more the result of COVID-19 than the current economic environment. That’s why you can’t look at real estate as one asset class. They’re all very different.

What drives the misconception about real estate in a rising interest rate environment?

Most people expect valuations to drop significantly as the cost of debt goes up. That’s a normal reaction, but it’s not necessarily the reality.

While there will be some isolated cases in which undercapitalized investors are being squeezed, broadly speaking, it’s not something we see happening. There’s so much capital in real estate that is very patient and has a long-term investment horizon. Buyers may be pausing similar to when the pandemic started, but we expect the activity to ramp back up soon.

What’s your outlook for the sector?

Maybe I’m too optimistic, but I think the current rising interest rate environment will be short-lived and rates go back down sometime early next year. Once that happens, we expect the market to rebound very quickly for most segments. Meanwhile, a lot of capital is sitting on the sidelines, waiting for the opportune time to jump back in.

What’s your advice for advisors looking at the private real estate market?

I recommend advisors consider private real estate as part of their clients’ portfolios. What I like about private assets is they’re not mark-to-market daily and can avoid the volatility and emotion experienced that often comes with investing in public assets. Private real estate investors are often more sophisticated, with a long-term vision. It’s why, for many ultra-high-net-worth investors, real estate represents a large portion of their investment portfolios.

This interview has been edited and condensed.

– Brenda Bouw, special to The Globe and Mail

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