Not to "D?" How about value-add real estate?

This article was produced by Principal Real Estate Investors as part of their valued Industry Partnership to Insurance Investor.

By John N. Urban, Managing Director, Portfolio Manager at Principal Real Estate Investors. 

Spring and wider access to COVID-19 vaccines in the US are leading to an uptick in economic activity, with a strong rebound in GDP expected this year. While interest rates are rising, many insurance companies still have an interest in the higher yields that alternative assets can generate, including equity real estate.

Previously we touched on the “D” word – Development investing. If that is not a fit for your firm, the next best higher yield alternative is to invest in value-add real estate, sometimes with operating partners, sometimes without, depending on the particular asset challenge.

Value-add investing is focused on buying assets that need some attention, typically some combination of improving a property due to age, functionality or cosmetic issues, leasing a property up to a higher level or bringing capital to the table to rescue distressed ownership situations. While we did not see widespread distress in commercial real estate markets as a function of COVID-19 (outside of particular property sectors), Principal Real Estate Investors is still seeing value-add opportunities in the apartment, office (need to be selective), data centre and life science sectors, among others. We expect to see levered returns in the high single digits to low double digits for these opportunities. We see very few real value-add opportunities in the industrial sector given robust investor demand for that property type.

If this type of property strategy seems to be a fit for your portfolio needs, there are two main ways to access these opportunities in the private market equity real estate world. First is by acquiring direct ownership of the properties either with or without a joint venture operating partner. This generally means a historical cost accounting profile is used which is helpful in protecting against GAAP losses in a downturn. However, it also results in a GAAP depreciation charge against operating income and appreciation is not recognised until sale. Alternatively, investing through a fund generally brings fair value accounting with both income and appreciation/ depreciation flowing through above the line.

Read about these topics and more in the latest issue of Insurance Quarterly.

MM11537A | 05/2021 | 1649827-122021