Private equity and direct investing in real estate is finding its way into retirement accounts. Most real estate pays dividends, which many people use as income. With around 10,000 people retiring every day from the baby boom generation, this group is rapidly growing; therefore, the need for income (in this case retirement income) is also growing, and its pace is only increasing.
Institutions and family offices have been investing in commercial real estate for decades. New structures and tech-enabled distribution are now making real estate available to a broader audience; including 401ks, IRAs and taxable retirement accounts.
There are several reasons why real estate makes a lot of sense for retirement:
- Retirement income can be well addressed by “preferred returns” or dividends in private equity real estate, and now as capital gains in UITs, REITs and other real estate structures.
- Income, well above the rate of bonds, CDs and bank accounts, is sorely needed by retirees to maintain their lifestyles.
- Income backed by hard assets has proven to be resilient and has also delivered long-term capital gains over full market cycles.
- Retirement accounts have longer time horizons, as does the asset class.
- Real estate can work in 401ks, IRAs (many of them advisor-managed) and self-directed IRAs as well.
Let’s look at each of these rationales individually.
Current Income. Dividends are typically paid from real estate operating profits, derived from rent collection, for example. Income is the primary driver for this investor segment, which is seeking to replace earned income with passive income. If, over time, this can be accomplished without eroding principal, it is a great win for retirees seeking current income to pay their bills. Historically, large segments of commercial real estate (even with the financial crisis of 2008) can demonstrate performance delivering dividends and long-term capital gains, as well as a hedge against inflation over a full market cycle.
Required Income is typically far beyond the risk-free rate of Treasuries. Achieving income targets needs to also address the risk/reward and lack of liquidity inherent in many structures of real estate investing. We see income of 5-9% from the bulk of quality offerings crossing our desks that typically meets or exceeds retirees’ criteria.
Packaging or product structure is really important, not just for payouts and profits, but for distribution and accessibility for this target investor segment. Advisors need to be able to add this investment in their asset allocation and be compensated based on their assets under management fees model. For most advisors, their older clients are also their larger clients, since they have been earning and saving the longest. They typically charge a fee based on the amount of assets managed and need this asset to be within their consolidated statement and custodian platform so that they can report and assess fees. Otherwise, the assets need to be with a custodial platform, like a self-directed IRA, where a retiree can monitor it and feel safe. This facilitates efficient direct marketing to advisors and large swaths of retirees and pre-retirees.
Time horizons. One’s time in retirement is defined by actuaries as the duration from retirement day until death. Hopefully, that is a nice, long time; which also creates a new term used by financial advisors—longevity risk, which is the risk of outliving one’s savings. With interest rates so low for so long, this is a real concern for retirees who don’t want equity market risk and need income to delay the erosion of their savings. One issue for investors in real estate is the timeline and lockups, which limits liquidity. If a manager can pay dividends (preferred returns), most retirees are willing to trade liquidity for benefiting from the current income.
Marketing is key to asset gathering and capital raising, especially for niche real estate managers. Like most investment asset classes, scale is required for efficiency and profitability. The industry is being embraced by financial advisors and (pre)retirees and is proving its value as an important slice of the asset allocation pie. Income backed by hard assets is not a short-term trend. You can’t fight demographics (remember the 10,000 people retiring each day). The need for current income will grow materially over the next 10 years, creating a major opportunity to market to individuals and their advisors for quality managers.