Why U.S. Real Estate?

Based solely on the size of the market, U.S. real estate is one of the largest asset classes in the world. It is estimated that the total value of all U.S. real estate is surpassed only by the value of the American stock market. The size of the market alone makes U.S. real estate worthy of consideration as a possible means of diversification in an investor's portfolio. But the following factors should also be considered:

1. 1. The relative stability of U.S. real estate.
2. 2. Its diversification effect on a portfolio.
3. 3. The liquidity issue.
4. 4. The relatively attractive returns from U.S. real estate today.

Considering all of these factors, we believe that U.S. real estate deserves a place in the portfolios of most high net worth individuals.

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1. The Relative Stability of U.S. Real Estate

All studies of investment grade real estate in the United States clearly show that this type of investment is a relatively stable asset class. The National Council of Real Estate Investment Fiduciaries (NACREIF) has been accumulating data on investment-quality properties for over thirty years, and their record shows that such investments experience less fluctuation during an economic cycle than do other asset classes. Capitalization rates (or yields) on U.S. real estate, which are the primary valuation measure for income-producing real estate, have generally remained in a range of from 7.5% to 10.5%. Yields in the bond markets over the past thirty years have moved in a significantly wider band. And valuation measures for common stocks have, of course, shown the greatest volatility.
The relative stability of income-producing real estate can be attributed to the fact that a real asset is involved, an asset that has an original construction value and a current replacement value. In addition, investors in real estate are long-term investors, and therefore the real estate market is usually not as susceptible to short-term investment considerations. It is always necessary to differentiate between speculative properties and land investments, on the one hand, and investment-quality income-producing properties, on the other. As with other asset classes, there is generally a great deal more volatility associated with speculative and non-income-producing real estate investments. An investor must focus on investment-quality, income-producing real estate to provide a portfolio with a degree of relative stability.

2. The Diversification Effect of Real Estate

The principal rationale for diversifying an investment portfolio is to moderate short-term fluctuations in the market value of the portfolio. To accomplish this, it is necessary to select assets that have a low level of correlation – in other words, assets that do not move in the same direction at the same time. The NACREIF studies indicate that the price movements of common stocks and real estate are not highly correlated. It may be somewhat of an over-simplification, but it is generally true that the stock market usually rises in anticipation of economic events, whereas real estate reacts only after an economic trend has developed. For example, the stock market began an unprecedented rise back in 1992 in anticipation of a prolonged expansion in the U.S. economy. On the other hand, it took several years after 1992 before the growth in the economy absorbed much of the vacant space in the real estate market so that rents and property valuations could begin to rise. The same lag effect is true in economic downturns, with the stock market anticipating those downturns and investment-quality real estate reacting to them, if at all, after the fact.

3. Real Estate Liquidity

Real estate is, of course, a relatively illiquid asset. Transactions in the real estate market, usually involving millions of dollars, can be expensive and time-consuming. In Falcon Real Estate’s view, the best way to deal with the relative illiquidity of real estate is to concentrate on investment-quality properties in the major markets of the United States. The U.S. real estate market is enormous and literally billions of dollars of properties change hands each year. Quality properties that are situated in major markets can almost always be sold in a matter of months. This does not, of course, equal the liquidity that is present in the stock and bond markets, but it should be sufficient for that portion of a portfolio that is allocated to a long-term, relatively stable asset.

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