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Getting the Balance Right in an HNW Real Estate Investment Portfolio

At CBRE Global Investors, Scott Spalding and his colleagues embrace what he calls “cycle awareness” in mapping out investment strategies for HNW clients.

In his new role as senior managing director and head of high-net-worth private markets for the Americas at CBRE Global Investors, Scott Spalding aims to apply an institutional-style investment approach to the HNW marketplace.

“This benefits high-net-worth investors and their financial advisers by providing them exposure to outstanding active managers at what can be viewed as institutional pricing,” Spalding says. “That has long been a tenet of the way that I’ve sought to do business, at my prior employer and here at CBRE Global Investors.”

At Los Angeles-based CBRE Global Investors, an investment management firm specializing in real estate, Spalding and his colleagues embrace what he calls “cycle awareness” in mapping out investment strategies for HNW clients. This includes a “keen focus” on both interest rates and cap rates, he says.

Spalding recently joined CBRE Global Investors from PIMCO, an investment management firm based in Newport Beach, Calif. As of Dec. 31, CBRE Global Investors had $103.2 billion in assets under management. The firm is an independent affiliate of commercial real estate services company CBRE Group Inc.

As Spalding settles into his new job, NREI caught up with him to get his thoughts on such matters as public versus private real estate assets, “cycle awareness” and inflation concerns.

The Q&A has been edited for length, style and clarity.

NREI: What kind of landscape are you seeing out there for public versus private investment for HNW investors?

Scott Spalding: Many high-net-worth investors are accustomed to investing in real estate through public markets. There are many benefits to investing in public REITs and stocks of real estate companies. We believe that strong portfolios should have exposure to both public and private real estate.

When we talk about public real estate, we have to realize that public real estate strategies provide exposure to real estate, as well as to the management talent and the financial structure of the company. So, when an investor owns certain public real estate strategies, an element of systematic stock market risk comes along with the exposure to changes in real estate prices.

If we go over to the private real estate side of things, private real estate strategies may allow investors to more fully realize the benefits from the moves in commercial estate prices. Private equity real estate strategies by nature involve active management. So, investment managers determine which geographies, sectors, subsectors and individual properties to buy, hold and sell. And these skills can add excess returns on top of market returns. That’s really the case for considering both private and public markets.

NREI: So, you feel that there should be a mix of both public and private real estate assets?

Scott Spalding: This is not an either/or decision in our mind. Rather, it is one where a strong portfolio should have exposure to both.

NREI: What’s your outlook regarding interest rates and cap rates?

Scott Spalding: One of the elements that has driven investment in private real estate has been the income-generating capabilities in private property markets. Specifically, they’ve looked at it relative to fixed-income alternatives. Indeed, this dynamic—the relative attractiveness in terms of income or yield—has powered cap rate compression.

We believe that the income levels related to private real estate will remain attractive, even as we begin to see interest rates increase in many countries, most notably here in the U.S. Although we expect interest rates to trend higher over the next three to five years, we expect inflation to remain in check and to be moderate by historical standards. With that rise in rates, it will put upward pressure on cap rates.

In terms of our strategy and how we’re viewing the market, we’re underwriting investments with cycle awareness in mind. This affects the selection of assets and how we structure financing to be able to hold through a potential adjustment in the economic cycle. Cycle awareness takes into account that there will be, in our view, a higher degree of differentiation of investment returns within the asset class moving forward. We think this benefits investment managers with skill and experience in investing through multiple market cycles, and very much so those with a keen sense of identifying what tenants are looking for in a property.

Overall, we’re focused keenly on rates. Although there’s not a lockstep relationship between increases in interest rates and increases in cap rates, we’re very aware of where we are in the cycle.

NREI: How should HNW investors be making sure they’re protected from rising interest rates?

Scott Spalding: This relates to a very top-level question: How does private equity real estate fit into a client’s portfolio? If it represents a new allocation within a portfolio, what asset class does it displace? It’s a very important topic for where we are in the economic cycle currently.

The case for private real estate in an asset allocation framework relates to three attributes.

The first is well-known: stable income. It’s currently one of the primary objectives of the high-net-worth investor and the institutional investor. Income is king.

Second is inflation protection. Lease agreements for commercial properties can be linked to factors such as the consumer price index or retailers’ merchandise sales. This helps… income yields for private real estate to keep pace with the general price levels in the economy. That explains how real estate can help provide some element of inflation protection in a portfolio.

Lastly, it’s just basic diversification. Private equity real estate has exhibited a low correlation to financial assets. We’re talking about real assets in terms of private real estate, and we compare that most often to financial assets such as stocks and bonds. Most types of bonds serve as a hedge against disinflation or deflation in a portfolio. Real estate, by comparison, serves as a hedge against inflation.

NREI: Some HNWs are more comfortable with the general category of real estate than others are. For those who may not be as comfortable with it, what would you say to them about what makes it an attractive component of an investment portfolio?

Scott Spalding: Generally, investors have increasingly come to appreciate the benefits of private real estate because of a few dynamics.

First is that coming out of the financial crisis, we saw a lot of central banks embrace zero-interest-rate policy. Zero-interest-rate policy has had negative consequences for yield-seeking investors. Investors who had traditionally relied on the bond market to generate the majority of yield in their portfolios have really had to broaden their investment opportunity set. We’ve seen a lot of interest in private equity real estate strategies because they generally have offered higher levels of income in comparison to other yield-producing asset classes such as bonds.

Secondly, as the economy has gained momentum, unemployment has fallen and wage growth has increased. This is sparking concerns over rising inflation, and investors—for the first time in a very long time—are thinking about adding inflation hedges to their portfolios.

The third element is that investors have experienced historic runs in stocks and other risk assets. Because of that, they’ve broadened their investment opportunity set as they continue to seek attractive returns.

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