Recent market shocks have investors on edge. After February’s spike in volatility and the largest one-day drop in the history of the Dow Jones Industrial Average (DJIA), many investors are wondering if the nearly decade-old bull market in equities is finally coming to an end.

Following the 2008 financial crisis, the equities market has outperformed almost all expectations and has provided a boon for investor’s portfolios. But with higher rates on the horizon and multiple other signs pointing to a potential shift in the market cycle, investors may want to trim their allocations to equities and explore other investment opportunities.

One sector that is attracting strong inflows right now is the U.S. commercial real estate (CRE) equity and debt markets. Over the course of my career, I have been involved in the funding or acquisition of several billion dollars of real estate loans, currently as the founder of a CRE lender. I’ve learned and personally observed the many different ways for investors to invest in CRE beyond just buying property. Savvy investors, including high-net-worth individuals, family offices and institutional investors, are now looking at all the opportunities within the CRE industry to achieve attractive, risk-adjusted returns. Compared to the increasing volatility of the equities market and the near-zero returns from bank deposits, CRE offers an attractive middle option that efficiently balances risk and return while providing cash-flow to a portfolio.

For investors considering CRE for the first time, there are two important things to keep in mind.

1. Debt Or Equity

Investors have two main options for CRE allocations.

Most investors are likely familiar with equity investments, which can take the form of buying stock in a company that specializes in CRE or buying a property outright. There are also various mutual funds and ETFs that can offer equity exposure to the CRE market. The risk-return profile of any individual equity investment can vary widely, so it is best to consult with a financial advisor before making any allocations.

On the other hand, private debt offers investors what I consider to be a safer and often more lucrative way to gain exposure to the CRE market. Unlike other forms of private debt such as consumer debt, student loan debt and small business debt, which are typically unsecured, real estate debt is backed by physical property as collateral. This collateral minimizes the risk of a default and provides a safety net of assets, should a default occur.

In addition, private debt backed by CRE offers stability to a portfolio (as there are no daily swings in price) and the option for monthly fixed income distributions. With absolute returns in the 6-12% range, you can see why this market is getting a lot of attention.

Choosing between a debt or an equity investment is all about timing the CRE market. Early in the cycle, it’s best to have equity ownership since that provides the highest return potential. But later in the cycle, it’s best to have debt exposure because risk is dramatically lowered. We are currently in the midst of the longest upward real estate cycle in a century, which suggests we’re likely close to the top of the cycle. Given the potential headwinds, CRE investors may be better off sticking to debt until the cycle restarts.

2. Which Specific Markets To Target

Like any asset class, not every CRE market is created equal. There are parts of the CRE industry that are undervalued, overvalued or somewhere in between.

Investors thinking about CRE should keep in mind that in a country as big as the U.S., CRE prices and valuations can vary widely from state to state and city to city. While the most mature CRE markets are in big cities such as Los Angeles and New York City, the best opportunities may actually be in suburban communities or in second-tier cities. For example, instead of Los Angeles, investors may want to look at Orange County or Riverside County where CRE prices are comparably cheaper.

The most successful CRE investors tend to have expertise in the markets in which they are investing. It’s important to understand the local market and what economic or demographic trends may play a role in driving up — or down — the value of a CRE property. Is the local population growing? Aging? Are there infrastructure projects in development that could make the property more profitable? Are there potential regulations that could cut into profits? Identifying these questions and, more importantly, the answers, can mean the difference between a modest loss and a huge return.

The CRE industry offers a great opportunity, outside of equities, for investors seeking to weather the turbulent markets ahead. It’s a growing market with an attractive risk-reward profile if considered carefully and strategically.

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