Why real estate is the next asset class to outperform


Brian D. Milovich

Managing Principal, Calvera Partners

The S&P 500 almost hit an all-time high in 2023. It produced a 24% return for the year when smart money thought a recession was brewing. Many investors remained in cash and missed this run. Uncertainty reigned supreme.

The certainty trade in 2023 was cash. Money market accounts and treasuries yielding 5%+ tempted investors to stay there. While investors waited for a recession, their money earned a solid risk-free return.

Fast forward to today–inflation has decelerated, and the economy remains on solid footing. As a result, stocks have moved much higher and long-dated bonds rallied to end 2023. There’s so much optimism about a soft landing that the market is betting the Fed cuts rates six or more times in 2024.

This optimistic view isn’t shared by The Fed. They are projecting three interest rate cuts in 2024 instead of six. Whether it’s three or six rate cuts, those easy 5% risk-free yields will soon be a thing of the past. This will start the process of making cash less attractive, raising the question of, “where should all that cash get invested?”

Stocks come to mind as the first place to deploy available cash. However, with the S&P 500 at elevated levels and its PE ratio at 26 (16 is the long-term average), the stock market feels fully valued. James Mackintosh in a recent WSJ article said of investing in 2024, “There are always new mistakes to make. But in 2024, bear in mind one of the oldest lessons: It is riskier to buy stocks when they are expensive because they offer little margin of safety to absorb bad news. Things can always work out but, with U.S. stocks so expensive already, the odds aren’t good.”

So, where should one look to invest so that they don’t miss out in 2024?

Real estate. Yes, as a real estate investor, I’m biased. But it’s one of the few major asset classes that still hasn’t recovered yet. The stock market was up 24% in 2023. Bond yields fell significantly from highs earlier in the year, meaning that prices soared to end 2023. Even Bitcoin rallied and returned 150% for the year.

Not all real estate is worth jumping into. Office properties remain a difficult proposition. Apartments, though, are attractive as they remain 20-30% off their highs from early 2022. A dearth of transaction activity and volatile interest rates have kept values low. It’s hard to value an investment when it’s thinly traded.

Apartment sales volume in 2024 should improve, as there will be more forced sellers. In 2024, many owners will run out of time with their lender, equity partner, or fund investment horizon. These distressed owners will have no other choice but to sell. This will begin the process of value discovery. It will also create a tremendous opportunity to buy apartment assets at discounts. And, it opens the door for considerable appreciation potential.

Apartment cash flow is the other component of return in real estate. This will also improve, especially when compared to risk-free assets. Let’s assume we buy an apartment property with net operating income (NOI) of $600k at a 6.0% cap rate. That’s a $10M purchase price. Let’s then assume we capitalize the deal with $3.5M of equity and a $6.5M loan at a 5.75% interest rate. The net cash flow after debt service would be $226k. This translates to a cash yield of 6.5% on equity, which is higher than money market account yields today. That 6.5% will look even better when money market account yields end up in the 3% or 4% range.

Between improved cash flow and appreciation potential, multifamily real estate is set to outperform in 2024.


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