With interest rates on the rise, persistent inflation, and the possibility of a potential recession looming on the horizon, many investors are struggling to see a light at the end of the tunnel.
But Ellen Hall, head of direct real estate at Fidelity Investments, sees opportunity.
As a portfolio manager, her goal is to find high-quality, commercial real estate properties that provide consistent income. Along with Cory Saunders, a real estate investment officer at Fidelity, Hall examines market, economic, geographic, and demographic data to identify the characteristics that would make a property a high-potential investment.
"Fundamentally, I think the real estate market is in a great place," says Hall. "With the exception of a few specific sectors, demand is very strong."
And given real estate's unique qualities as an asset class, it may be able to provide a degree of stability that can help offset the volatility investors are seeing in their stock and bond investments and could potentially act as a hedge against rising inflation.
As consumers move online, warehouses trump retail
For Hall and Saunders, one important real estate trend in the post-pandemic market is the explosive growth of ecommerce. The pandemic accelerated the uptake of online shopping and created new supply chain challenges for companies, increasing demand for "industrial" properties that serve this market.
"When you talk about industrial, people think you mean factories. It's not that at all," says Hall. "We're talking about a typical warehouse that an ecommerce company might use. We call them distribution or logistics buildings. That's what we're focused on."
While traditional retail properties have become less attractive, there are exceptions, says Saunders. Though malls anchored by traditional department stores have suffered as shoppers move online, those that are anchored by consumer staples, such as grocery stores, have fared better. "Where we are seeing strong performance in retail is with grocery-anchored malls or shopping plazas."
Hybrid and remote work are transforming the market
While the shift away from retail was already apparent before the pandemic, the sudden change in fortune for office spaces was somewhat unexpected.
"For the last 2 years or so, many offices have been closed and, in general, having employees working remotely worked well," says Hall. "As a result, a lot of corporations are rethinking their need for office space, both as a means of reducing costs but also, frankly, to attract talent. Employees expect to work hybrid now, and while we still think there will be some demand for office space, what that looks like exactly is still to be determined. Offices that are newer, in prime locations, and full of modern amenities are still faring well, but overall, the whole sector is a question mark."
The increasing prevalence of remote or hybrid work has also influenced the demand for residential properties, leading many to seek out larger, more comfortable spaces that can accommodate the new arrangement. Given how much competition there already is for residential real estate, it may put further pressure on an already strained market. "The whole country is underserved from a residential perspective," says Hall, "and rising mortgage rates are making the problem worse."
Finding a favorable formula
"Compared to offices, industrial properties are better suited for our core style of investing. They take much less capital to prepare for the next tenant when the existing one moves on. They're generally less volatile in terms of future cash flows. The same is true for multifamily residential properties," says Hall.
With these broader trends in mind, Hall and Saunders narrow their search for high-potential properties by identifying major metropolitan areas that fit a particular profile: regions with strong population growth, highly educated populaces, good fiscal health, and high livability scores. They then consider factors specific to real estate, which helps them gauge whether they can continue to expect strong demand in the long term.
"We weigh the fundamentals of demand against the dynamics that affect how difficult it is to introduce new supply into a market," says Saunders. "So, imagine a city with a very highly educated, growing population and very high barriers to getting new construction approved. We think that's a favorable formula for durable rental growth."
Real estate as a diversifier
Given the ongoing volatility and uncertainty in the stock and bond markets, investors may consider adding exposure to real estate in their portfolios. Real estate investments have tended to perform differently than stocks and bonds, and when incorporated into a traditional, 60/40 portfolio, they may help provide diversification benefits.
"Public markets, by definition, are much more volatile," says Hall. "The changes in price can be large and fast, whereas private real estate has historically been more stable. The value of a building generally doesn't change overnight; it moves at a slower place."
Furthermore, real estate may be able to help provide some protection against the risk of inflation.
"Real estate can adjust quickly when inflation begins to rise," says Hall. "Especially in multifamily properties, you can increase rent each year to compensate. Industrial or office leases may be flexible, as well. They often have indexation clauses where rents rise year over year and mitigate the impact of inflation. That's why you historically see real estate outperform in periods of high inflation."
Real estate may help provide a solid foundation
In uncertain times, the relative consistency of real estate can be a balm to investors looking to help steady their portfolios. And given the transformative shifts in real estate following the pandemic, this may be a good time to consider whether real estate can play a role in your portfolio.
How Fidelity Private Wealth Management® clients can qualify for our alternative investments program
Because alternative investments come with unique sets of risks, the requirements governing who can participate in this program are different than those of traditional investments. While your Fidelity advisor can help you better understand these requirements, which often vary from offering to offering, participation in the program is generally only available to qualified purchasers enrolled in Fidelity Private Wealth Management.