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Institutional investors are targeting, on average, a 10.7% allocation to real estate, but their current allocation is 80 basis points lower, at 9.9%.¹ Interest rate-driven declines in real estate portfolio values, combined with the strong performance of public equities in 2023 and 2024, contributed to an under-allocation to real estate. US private commercial real estate’s Open End Diversified Core Equity (ODCE) fund delivered a -12.0% total return in 2023 and -1.4% in 2024, after 13 consecutive years of positive returns. Public equities delivered 26.3% in 2023 and 25.0% in 2024, further widening the allocation gap. Despite an under allocation to real estate, institutions have largely refrained from making additional investments over the past two years. Concerns over elevated interest rates, muted transaction volumes and write-downs were stalling new capital allocation.

Despite current capital market challenges, recent data signals that real estate values have mostly aligned with the current cycle and transaction volumes have started to pick up. After more than two years of adjusting to higher interest rates, capital returns in most sectors turned positive during the second half of 2024. Improving capital market conditions and stabilizing debt costs supported commercial real estate transaction activity during the fourth quarter of 2024, which according to MSCI-RCA, was 40% higher than 4Q23 levels. Total 2024 volumes also exceeded 2023 levels by 12%. Transaction volume is poised to continue to grow in 2025, generating more conviction that markets have bottomed out.

As debt markets thaw and transaction volumes rebound, we can expect allocations to real estate to pick up again. Downturns are rare in private real estate, which implies that the recoveries that follow them bring rare opportunities to establish a good basis and add diversification. Real estate remains a vital component of a diversified portfolio. Although the focus is now more nuanced, with a growing emphasis on sectors with strong long-term tailwinds, the asset class maintains a solid footing in achieving strong long-term risk-adjusted returns, as seen in Figure 2.

Private real estate has long been a staple in institutional investors’ portfolios, providing diversification, stable long-term returns, and an inflation hedge. Despite the evolving investment landscape, private real estate continues to positively contribute to long-term strategic planning.

Diversification

Private real estate is often less correlated with the public markets. This means that performance does not always move in the same direction as other asset classes, offering a buffer against risk factors that impact the public markets. By investing in asset classes that respond differently to market conditions, investors can reduce risk while achieving more consistent returns over time.

Figure 1: 30-year correlation across asset classes

Stable long-term returns

Over the long term, private real estate has achieved competitive risk-adjusted returns. With a Sharpe ratio of 0.9, private real estate delivered the highest return for the level of risk taken across asset classes over the past 30 years.

Figure 2: 30-year risk-return summary across asset classes

Although real estate performance has been weak over the past two years, downturns have been rare historically. Since NCREIF began in 1978, total returns have been positive nearly 90% of the time. Historical data reveals that on a rolling 10-year basis, unlike US equities, private real estate has consistently posted positive returns over the past 30 years, as shown in Figure 3. On a rolling 10-year basis, private real estate has also consistently performed better than US bonds and Treasury bills over the past 23 years, except for a slight dip below US bonds in 2009 and 2010. Current market dislocation offers a rare opportunity to enter the private real estate sector at an attractive basis. 

Figure 3: 10-Year Rolling Average Annual Total Returns by Asset Class

Source: NCREIF, Moody's, NAREIT, Bloomberg. Data through 4Q24. US private real estate data is represented by Open End Diversified Core Equity (ODCE) Index, US equity is represented by the S&P 500 Total Return Index, US bonds is represented by the Bloomberg US Aggregate Bond Total Return Index, and US REITs is represented by the All-Equity REITs Index from NAREIT. Past performance is not indicative of future results.

Private real estate can provide stable and predictable cash flows. Rental income is the primary source of revenue for real estate investments, and as the price of goods and services goes up, rents tend to track closely. With inflation diminishing the value of money, increases in rent help preserve the value of income streams. Over the long-term, private real estate net operating income has kept pace with inflation.

Figure 4: Private real estate Net Operating Income Growth versus Inflation (Index, 1995=100)

Source: Bureau of Labor Statistics, NCREIF, Moody's Analytics. Data through 4Q24. Indexed same-store net operating income is calculated using the NCREIF Property Index. Inflation is the Consumer Price Index (CPI). Past performance is not indicative of future results.

Despite shifting market conditions, private real estate remains attractive, offering strong returns, inflation hedges, and diversification benefits. As debt markets begin to recover and transaction volumes increase, real estate allocations are expected to rise again, providing opportunities for investors to build a solid foundation and enhance portfolio diversification in sectors with long-term growth potential.

^1. 2025 Investment Intentions Survey, PREA. Survey results were carried out between October and November 2024