Recovering US real estate

Looking to construct a real estate portfolio that participates in the US’s revived housing market? The folks at Deutsche Asset & Wealth Management have constructed a diversified portfolio that they say should give you a solid 5.5% per annum over the next five years after adjusting for inflation. Mark Roberts, the bank’s managing director of real-estate investment, is particularly upbeat about office and industrial real estate, which have historically outperformed when the economy was improving.

As the housing market has recovered, certain sectors have heated up faster than others. Last year, demand for apartments expanded as Millennials continued to choose rentals over purchases. Though this sounds positive for apartment-building investments, Roberts remains underweight because new construction is flooding into the market. Retail real estate also faces some headwinds owing to its relatively long leasing periods that could leave it exposed when rates rise.

Still, the office and industrial sectors will continue to be the gems in investors’ real estate portfolios. There Roberts is eyeing between 6% and 7.5% annual returns over the coming five years. Industrial real estate investments will benefit from the supply of warehouses lagging demand. Trade, particularly with China and other Asia Pacific countries, will continue to benefit the industrial portion. The large-bay warehouses of Atlanta, Chicago, Dallas, and New Jersey will generate above-average returns, Roberts says.

The bullish trend for office space investments is a bit more obvious. As job growth prospects continue to brighten and companies open new facilities demand will grow. Factor in limited new construction and the office sector should produce rising yields, Roberts says. Markets like Miami, Ft. Lauderdale, and California’s Orange County are the best bets. But Deutsche is underweight places with high concentrations of Federal government workers, Roberts says. That would obviously mean Washington D.C., but could also hurt others such as San Diego with big armed forces or other federal ties.

A diversified basket of real estate holdings should offer the most benefits. “Real estate is an income producing asset that is backed by bricks and mortar,” says Roberts, “and that means there is generally lower downside and volatility than what you would see in certain high-yield fixed income sectors or the equity market.” On average, yields on real estate are now three percentage points above superlow 10-year Treasury rates, which is better than their historical premium of 1.75 to 2.25 percentage points. “Couple this with limited new construction in most markets and that means when rates do rise these above-average earnings provide a nice shock absorber that should limit the capital market risk,” he says.

Deutsche Asset & Wealth Management constructs bespoke real estate portfolios for its high net worth clients. As a general rule of thumb, real estate should represent between 10% and 20% of your overall wealth, Roberts says.

Another nice way to get exposure is through private-equity vehicles. An excellent resource: Alternatives investment data provider Preqin’s recently released its 2014 list of the “most consistent performing” private equity real estate fund managers. These managers had funds that were in the top 20% in performance and were up, on average, 80% over the past five years, versus less than 20% for those in the bottom 80%. Among the top managers making the list: JBG Companies, Carmel Partners, Centennial Holdings, and Embarcadero Capital Partners.

This article was first published in Barron’s, and is reproduced with permission.