Historically, institutional investors have favored companies that own and operate traditional property types — office, retail, industrial, apartments, and lodging/resort. These “core” real estate assets are attractive investments for providing greater diversification, reliable income, and predictable yield. Today, market sentiment remains bullish, despite the major economic disruption in 2020. In 2021, the industry experienced record-high investment activity with transaction volumes topping $808.7 billion according to Real Capital Analytics. Declining Treasury yields have also compelled institutional investors to inject more capital into the real estate market (Figure 1). However, this heightened demand for real estate assets, especially traditional property types, has sent prices soaring, compressing investors’ yields. Consequently, institutions are increasingly looking to add non-traditional property types — self-storage, manufactured homes, healthcare, data centers, etc. — to their portfolios in search of higher yield-based returns.
Figure 1 — Source: Federal Reserve of St. Louis
One of the major constraints on investing in alternative property types is the limited and inconsistent historical data in both the public and private markets. The National Association of Real Estate Investment Trusts (NAREIT) has collected 35 years of historical data for publicly listed, non-traditional real estate investment trusts (REITs) such as self-storage, manufactured homes, and healthcare, and 5 years of historical data for other emerging niche property types such as data centers and single-family homes. Conversely, the National Council of Real Estate Investment Fiduciaries (NCREIF), which serves to reflect the historical performance of institutional investment in the private sector, has only 15 years of historical data for alternative classes including self-storage, senior living, and healthcare and provides no history on the emerging sectors of data centers and single-family homes.
Considering that most institutional investors’ primary focus is to allocate capital to safe and historically well-established assets, it would be counterintuitive for them to invest into newly emerging and unknown property types. However, the passage of time allows us to collect more information that adds to our knowledge of these non-traditional sectors. Perhaps the concerns of limited data and high volatility have been remediated so that these sectors deserve a fresh appraisal.
Over the past 15 years, both the public and private markets have seen substantial growth in market size. In the public sector, the U.S. market capitalization for publicly-listed equity REITs tripled in value from $277 billion in 2005 to $842 billion by the year-end 2020 (NAREIT). Similarly, the private markets grew three times in value over the same 15-year time horizon from $192 billion to $727 billion. Even though the public and private sectors experienced comparable growth trends for the given time horizon, Figure 2, reveals a unique factor behind the public market’s growth; the share of REITs’ allocated to non-traditional property types. At the year-end of 2005, traditional asset classes dominated the public market by accounting for more than 90% of the total market capitalization. Today, REITs focused on nontraditional asset classes grew from 10% to more than 42% of the total REIT market share.
If we break down the total REIT market capitalization by property sector, we see even more shocking discoveries. Figure 3 (A&B) shows that the traditional property types of retail, office, and apartment dominated the market share back in 2005. However, as alternative property sectors gained more popularity, almost all traditional property sectors saw sharp reductions in overall market share. Most noticeably, the once-dominant retail and office sectors shrunk to half of their original size. Conversely, all non-traditional asset classes experienced increased market acceptance. Self-storage and healthcare doubled in market size. Datacenter REITs which were once nonexistent in the public REIT space, now make up more of a percentage than office and lodging/resort sectors.
In the private sector, non-traditional properties types constitute only 6% of the NFI-ODCE, NCREIF’s Open-end Core index, in 2021. Non-traditional property types have seen minimal growth during the same 15-year time frame rising from 1% to only 4% of the overall private market share. Self-storage, with a market value of just over $12 billion, is the largest of the non-traditional property types in the private market. Although NCREIF data shows institutional investors being more reluctant to accept these alternative assets, self-storage is showing indications of increased market acceptance. More specifically, the number of self-storage properties tracked by the NFI-ODCE index jumped from 135 facilities in 2012 to 354 facilities in 2021, which is greater than the number of hotel properties and catching up to retail and office property counts.
Figure 2 — Source: National Association of Real Estate Investment Trusts
Figure 3A — Source: National Association of Real Estate Investment Trusts
Figure 3B — Source: National Association of Real Estate Investment Trusts
Over the last twenty years, data shows the yield differentiation between core and niche properties has grown considerably as alternative property types continue to demonstrate strong historical performance. As shown in Table 1, over twenty-year and fifteen-year timeframes, alternative asset classes outperformed all traditional property types. Specifically, self-storage and manufactured home sectors have delivered double-digit returns in the high teens for every time horizon. As for traditional sectors, industrial and apartment sectors are the only traditional property types producing similar yields.
In more recent years, emerging niche sectors generated significantly greater returns than most traditional asset classes. Data centers and single-family home sectors outperformed nearly all traditional property types over three- and five-year timeframes. Conversely, traditional properties such as retail, office, and lodging/resorts offered significantly smaller yields than almost every alternative asset class.
In the private market, performance return trends have been consistent with the public market. According to the property-level returns data from NCREIF displayed in Table 2, alternative property types performed relatively well compared to most traditional product types. Self-storage, in particular, outperformed all traditional product types except the industrial sector. Additionally, the traditional sectors – retail and hotel – were the only property types to report negative returns to investors. It may be true that data collection for alternative property types is limited but returns for alternative sectors are very strong.
Another key metric to consider is a sector’s volatility over a particular period. Given the perceived risky nature of alternative property types, one would suspect that traditional property sectors would prove to be less volatile investment strategies. Interestingly, alternative property types have shown similar and even lower levels of volatility compared to traditional properties. According to data from NAREIT Table 1, manufactured homes and healthcare, in particular, experienced lower levels of volatility than every traditional property type over the given timeframes. Even well-performing “core” assets such as the industrial sector have experienced some of the highest volatility (29.1%) through recent years. Lodging/resorts have proven to be the most volatile investment among all property types.
Non-Traditional Property Sectors: Standard Deviation
Single Family Homes
Table 1 — Source: National Association of Real Estate Investment Trusts
In the private markets, volatility results are not as compelling as they are in the public markets. They offer some contradicting results, as private traditional property types show mixed volatility levels compared to non-traditional sectors Table 2. Healthcare offered the lowest volatility over the past 10 years but the results across both traditional and non-traditional sectors along different periods do not consistently point in either direction. Self-storage offered lower volatility than industrial and hotel properties. Risk-averse private investors might combine similar volatility measures with the long history of the traditional sectors to favor these investments.
Non-Traditional Property Sectors: Standard Deviation
Table 2 — Source: National Council of Real Estate Investment Fiduciaries
Making the case for Mainstream
Based on the above performance metrics, it is evident that non-traditional asset classes, especially in the public market, have closely rivaled if not outperformed traditional property sectors over recent history. Some investors might counter the high return performance of non-traditional sectors by suggesting high risk, short history, and thin markets as reasons to avoid these investments. These were valid limitations of the non-traditional sectors in the past, but time is shining a light on some of the concerns. Accordingly, now seems like an appropriate time to evaluate which of these non-traditional asset classes makes the strongest case for transitioning from a “niche” to mainstream real estate investment. To answer this question, we must narrow down the candidates.
First, let’s examine the sectors with exposure to both the public and private markets. Although the public markets have fully embraced several non-traditional sectors, the private markets seemed to have only truly recognized self-storage and healthcare as alternative property types. Due to their dual exposure, these two sectors seem like lead candidates for mainstream acceptance.
Focusing now on the historical performance of each alternative property type, self-storage, manufactured homes, and healthcare generated attractive performance yields with acceptable volatility in the public markets. As for the private sector, self-storage and senior living performed relatively well compared to traditional sectors in the private markets. Out of all alternative property types, self-storage seemed to be the only consistent, well-performing property type among the private and public markets which further strengthens its case for the nomination.
Finally, the collection of historical data is a limiting factor for some of the non-traditional types. Newly emerging sectors such as data centers and single-family homes have performed extremely well during the past few years. However, both of these sectors have a short history in NAREIT (6 years) and are nonexistent in NCREIF. Given this limitation, it is reasonable to exclude data centers and single-family home rentals from consideration due to their limited history at this point. Continued performance like the past five years will make these good contenders in the future, but today, it is too early to tell. On the other hand, the self-storage and healthcare sectors are the only non-traditional sectors with similar historical data timelines to the traditional asset classes. However, healthcare seems to have missing data entries in NCREIF data, while self-storage has shown consistent data collection.
Given the above considerations, self-storage makes the strongest case for becoming a mainstream investment property. Over time, self-storage has shown consistent and strong performance metrics that closely rival, if not outperform traditional property types in both the public and private markets. Increasing market acceptance, rising institutional investment, and greater market data availability have allowed this sector to distinguish itself from its alternative counterparts. A deeper analysis of the sector’s transition period should shed light on whether or not it should now be considered a core investment property type.
The perception of self-storage facilities has changed significantly in the last decade as properties have become more sophisticated, automated, and mainstream. Consequently, the sector has become one of the most desirable asset classes among a broad array of investors. Driven by strong fundamentals and a proven track record of recession resiliency, investors’ market sentiment continues to remain bullish. Today, almost 10% of U.S. households are currently renting a self-storage unit. Aside from this, self-storage facilities offer significantly cheaper overhead costs compared to traditional property types, allowing for greater income potential for investors. As a direct result, this accelerated demand combined with attractive property fundamentals has pushed the sector to perform exceptionally well.
Figure 4 — Source: National Association of Real Estate Investment Trusts
In Figure 4, we see the hypothetical growth of a $10,000 investment into self-storage REITs compared to that of traditional REIT property types. Clearly, self-storage REITs dominated core properties in terms of cumulative return as the index skyrockets past that of all traditional property types. In fact, over the past two decades, self-storage REITs only reported two years of negative annualized returns, which was the lowest amount compared to all traditional sector REITs. A similar result can be produced with private return numbers. Self-storage properties have also demonstrated remarkable resilience through recent downturns. During the 2008 recession, self-storage was the only sector to produce positive growth. During the time that the All Equity Index declined by 40%, the self-storage sector grew by 5%.
Self-storage investments have now caught the attention of the institutional players as evidenced by the Blackstone Real Estate Trust’s (BREIT) purchase of Simply Self Storage. The sector’s strong returns and recession-resistant nature have driven exceptional performance, with acceptable volatility, in both the public and private markets. As a direct result, self-storage seems to have repositioned itself from a “niche” investment property to a “traditional” sector. If we were tasked with nominating a sector for the “traditional” category, self-storage is our clear choice.
Infrastructure and timber sectors have been excluded from this analysis
because they do not contain tangible buildings. Diversified and specialty
REITs are also excluded because they consist of multiple property types.
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