Real estate has long been a favored asset class for baby boomers due to its stability and lack of correlation to core equities. In fact, with real estate representing 44% of boomers’ net worth, no generation has held more real estate wealth than Americans born between 1946 and 1964.1
However, attitudes of the next generation toward commercial real estate are different. While boomers saw opportunity in active ownership, many in the younger generation only see opportunity cost of their time and money.
These opposing views on real estate are likely to shape investment decisions as this piece of the portfolio undergoes generational wealth transfer. This raises the question: is it prudent to leave commercial real estate properties for the next generation to actively manage?
From an investment perspective, the answer is a resounding yes. Direct ownership of commercial real estate, generating historical annualized returns in line with equities (~8%) with the volatility of bonds (~4%), has been a core driver of wealth creation.
Historical Risk and Return2
Despite the near-term challenges of certain pockets (office), we continue to believe that the longer-term rationale for the core role of real estate remains intact. It is simply the relationship to real estate, and the form in which it is owned, that is likely to evolve.
Baby boomers have a very intimate relationship with their real estate investments. That’s expressed as a preference for owning it directly and, in many cases, operating it as a full-time job.
Members of the next generation (“next gen-ers,” ages 21–42) don’t want that type of relationship. They are often more spread out geographically, deeply engaged in their own careers and less willing to engage in active property management. Additionally, relative to the boomers who had the proverbial “wind at their back” with low interest rates, next gen-ers cannot rely on financial engineering to create value. In order to drive value creation, they must be much more active in property management than their predecessors. As a result, many want to retain the value but are OK with—and actually prefer—being disassociated from the properties themselves.3
A passive approach for evolving opportunities
From our perspective, the generational wealth transfer for real estate becomes about transitioning from active to passive management, from an owner/operator perspective as well as an investment one. We believe the key for an advisor is to recast next gen-ers’ “relationship” with real estate—transitioning it from the intimate, active model of prior generations to a more passive one.
Active vs. Passive Management
Active: Directly owning distinct properties whose value depends on the work that the direct owner personally performs.
Passive: Indirectly owning a diversified portfolio of properties whose value depends on third-party owner/operators and the market.
To achieve this, baby boomers—or next gen-ers who have already received direct ownership rights—have at their disposal a few ways to transition out of direct ownership and management but also to “right-size” the real estate allocation as a part of their total investment portfolios. These options include utilizing a Delaware Statutory Trust (DST), as a more diversified, higher-quality version of direct real estate; participating in a 1031 program whereby property undergoes a 721 exchange/UPREIT process; or even acquiring a triple-net lease.
While there are a few options for ways to get there, most ultimately result in the opportunity to continue to own real estate, but in a unitized, divisible way, using a non-traded REIT (NTR). An NTR is generally accepted to be the most efficient way to indirectly (or “passively,” to use the phrasing above) own commercial real estate.
The amount of the NTR one ends up owning is based on the dollar amount transacted. Once the transaction is complete, thinking should transition to percentage terms: What percentage of the total investment portfolio does that NTR now represent? Because now it’s just an asset in the portfolio—one that has historically demonstrated strong diversification and can also deliver reasonable returns (balanced between income and capital appreciation) over time.
For these more objective investment reasons, we believe real estate deserves to maintain a core place in the portfolio. Whether through the direct owner/operator model championed by the baby boomers or through the transitioned model toward a diversified “passive” investment that works within the broader investment portfolio, either approach allows commercial real estate the opportunity to do what it historically has done best: deliver durable, cycle-tested returns over the long-term while diversifying against other traditionally core holdings of corporate equity and debt.
In our view, the most suboptimal outcome of intergenerational real estate wealth transfer would be to fully divest from real estate altogether. Real estate really does have an important role in an investment portfolio for the next gen-er—just a different type of role than when it was held by the baby boomer.
