Commercial Real Estate Combines Stock And Bond Characteristics

Posted by Vident Financial on 1/28/19 10:33 AM

Looking at the chart below, we see on the left side a ranking of performance of 3 bond sectors and one equity sector with fixed-income type characteristics, real estate.

Real estate was one of the best performers of the group for the first 3 quarters of 2018. But there is a great reversal of that in the fourth quarter -- real estate goes from being one of the top performers for the first 3 quarters of the year to the 2nd worst performer for the final quarter of the year. This is important because real estate is an asset class which acts in ways that are both bond-like and stock-like. That is partly because it has a growth component, which depends on expansion as economic growth gives commercial property higher occupancy rates and higher real rental fee increases as the value is bid upwards. This makes REITS partly responsive to growth expectations. But real estate also acts somewhat liked fixed income in that real estate indices make money largely on locked-in lease agreements (which act somewhat like bonds or bills).

So as growth expectations fall, real estate will tend to underperform the bond complex, due to its stock-like features, but it also tends to outperform equities due to its bond-like features. It will tend to rise compared to stocks and fall compared to bonds, with returns that tend to cluster between equity and stock returns. We see that going on below as real estate moved from second best performer in the displayed bond sectors during the first 3 quarters of the year, to worst performer in the last quarter of the year.


Bond returns in 2018 with real estate

But real estate performed quite well compared to other equity types:

Equity Returns 2018

Both observations are consistent with falling growth expectations. The take-home for investors is that during slow-downs, real estate creates an important category of possible diversification. As stocks sell-off and bonds surge, real estate decreases the draw-down in equities, smoothing the ride a bit by providing a category between the highly divergent returns of stocks and bonds. High yield is already well recognized as occupying that space, but investors are much less aware that real estate is an additional option in that space, especially for investors who have qualms about 'junk bond' levels of quality.

Topics: equities, Bonds

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