Relative value and the case for real estate credit
Since the Great Financial Crisis, the number of private credit funds, mortgage real estate investment trusts, and nontraditional sources has risen fourfold, from about 2.5% in 2009 to 10.0% today. This trend is likely to continue even as monetary policy shifts from rate hikes to rate cuts, given the relatively stable risk-adjusted returns offered by real estate credit in comparison to corporate credit and real estate equity.
The composition of the U.S. CRE market
U.S. commercial real estate (CRE) credit is a $4.7 trillion market with a diverse set of lenders: banks, agencies, life insurance companies, commercial mortgage-backed securities (CMBS), and private credit funds such as real estate credit strategies (RECS). From 2020 to 2024, private real estate credit lending increased by 40.6% compared with the prior four years (2016 to 2019). By contrast, public real estate credit (CMBS) and bank lending to real estate fell by 28.2% and 17.9%, respectively.1
Public vs. private real estate credit (US$ billion)
Source: Mortgage Bankers Association; Manulife IM RECS calculations, as of August 2024.
Banks remain under pressure to reduce their CRE exposure, given increased regulation and market perception.2 Continuing refinancing challenges that drive CRE repricing represent opportunities for private credit lenders to fill the gap at attractive entry points.
Real estate credit’s strong, consistent yield in comparison with other benchmarks
Real estate credit has historically offered relatively stable returns given its ability to mimic fixed-income-like features, unlike widely used real estate equity benchmarks such as the NCREIF Property Index (NPI) or the NCREIF Fund Index for Open End Diversified Core Equity (NFI ODCE). The five-year average return for NCREIF’s NPI, for example, which captures both income and appreciation returns from unlevered real estate equity investments, is 4.69% over the five-year period from Q2 2019 to Q2 2024. This compares favorably with other real estate investment benchmarks.
Select benchmarks: five-year performance comparison (%)
Source: NCREIF, J.P. Morgan, Manulife IM RECS References, as of August 2024. NPI refers to the NCREIF Property Index. NCREIF ODCE refers to NCREIF Fund Index for Open End Diversified Core Equity.
Compared to a diverse set of investment benchmarks, we believe real estate credit offers relatively strong, consistent yield. Risk metrics such as standard deviation of returns over time show that real estate credit also offers relatively low variability, particularly compared to equity options such as the S&P 500 Index or NCREIF’s NPI.
Risk/return performance of select indexes (%)
Source: Standard & Poor’s (S&P 500 Index). Federal Reserve Bank of St. Louis, ICE Bank of America. Private RE equity is the NCREIF Property Index. Public RE equity is the S&P All Equity REIT Index. RE credit are CMBS BBB yields, as of August 2024.
RECS compare favorably against typical investment benchmarks because of their flexible investment mandate: Their ability to implement bespoke deal structuring through the benefit of equity-like due diligence compares favorably with corporate bond investments that are typically unsecured and offer no collateral support. RECS have the benefit of positioning real estate as collateral in addition to the equity cushion supporting investment positions. If appropriate, RECS can demand a recourse guarantor (including a “warm body" guarantor) as part of the loan structuring—parties that are obligated to assume indebtedness in case the borrower defaults—a structure that can enhance risk-adjusted returns.
Investment Considerations
General Risks
Any characteristics, guidelines, constraints, or other information provided for this material was selected by the firm as representative of the investment strategy and is provided for illustrative purpose only, may change at any time, and may differ for a specific account. Each client account is individually managed; actual holdings will vary for each client and there is no guarantee that a particular client’s account will have the same characteristics as described herein. Any information about the holdings, asset allocation, or sector diversification is historical and is not an indication of future performance or any future portfolio composition, which will vary. Portfolio holdings are representative of the strategy, are subject to change at any time, are not a recommendation to buy or sell a security, and do not represent all of the securities purchased, sold or recommended for the portfolio. It should not be assumed that an investment in these securities was or will be profitable. Top ten holdings information combines share listings from the same issuer, and related depositary receipts, into a singular holding to accurately present aggregate economic interest in the referenced company.
No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. Diversification or asset allocation does not guarantee a profit or protect against the risk of a loss in any market. The indices referenced herein are broad-based securities market indices and used for illustrative purposes only. The indices cited are widely accepted benchmarks for investment performance within their relevant regions, sectors or asset classes, and represent non-managed investment portfolios.
If derivatives are employed, note that investing in derivative instruments involves risks different from, or possibly greater than, the risks associated with investing directly in securities and other traditional investments and, in a down market, could become harder to value or sell at a fair price.
GIPS Performance
Unless otherwise noted, all performance represents composite data. Gross of fees returns do not include advisory fees and other expenses an investor may incur, which when deducted will reduce returns. Changes in exchange rates may have an adverse effect. Actual fees may vary depending on, among other things, the applicable fee schedule, portfolio size and/or investment management agreement. Unless otherwise noted, returns greater than 1 year are annualized; calendar year returns for each one-year period end in December. Discrepancies may occur due to rounding. Past performance does not guarantee future results.
Performance information shown is generally for discretionary strategies/solutions and managed by a Manulife entity which is GIPS compliant and falls under the definition of a corresponding Manulife GIPS firm. Some investment strategies/solutions may not be included in a GIPS compliant firm under certain circumstances, such as SMA/UMA business in Canada.
Asset class risks
Principal risk factors that have an impact on the performance of our equity strategies include risks arising from economic and market events, portfolio turnover rates, governmental regulations, local, national and international political events, volatility in the commodities and equity markets, and changes in interest rates and currency values as well as environmental, social and corporate governance factors.
The principal risks associated with investing in a fixed income investment strategy include economic and market events, government regulations, geopolitical events, credit risk, interest rate risk, and risks associated with credit ratings, counterparties, foreign securities, currency exchange, hedging, derivatives and other strategic transactions, high portfolio turnover, liquidity, mortgage-backed and asset-backed securities, call or prepayment risk, and issuer stability along with environmental, social and corporate governance risk factors. The market value of fixed income securities will fluctuate in response to changes in interest rates, currency values and the credit worthiness of the issuer.
Principal risk factors that impact upon the performance of our asset allocation strategies include all the risks associated with the underlying funds and asset classes in which they are invested, in addition to overall asset allocation investment decisions. In addition, the underlying funds’ performance may be lower than expected.
Information about SFDR
Unless otherwise noted, any references in this presentation to ESG or sustainability reflect the general approach of Manulife Investment Management to integrating sustainability risk considerations into our investment decision-making processes. Further details on Manulife Investment Management’s general approach to sustainability are available at www.manulifeim.com/institutional/global/en/sustainability. The source for all information shown is Manulife Investment Management, unless otherwise noted.
ESG Integration and Engagement
Any ESG-related case studies shown here are for illustrative purposes only, do not represent all of the investments made, sold, or recommended for client accounts, and should not be considered an indication of the ESG integration, performance, or characteristics of any current or future Manulife Investment Management product or investment strategy.
Manulife Investment Management conducts ESG engagements with issuers but does not engage on all issues, or with all issuers, in our portfolios. We also frequently conduct collaborative engagements in which we do not set the terms of engagement but lend our support in order to achieve a desired outcome. Where we own and operate physical assets, we seek to weave sustainability into our operational strategies and execution. The relevant case studies shown are illustrative of different types of engagements across our in-house investment teams, asset classes and geographies in which we operate. While we conduct outcome-based engagements to enhance long term-financial value for our clients, we recognize that our engagements may not necessarily result in outcomes which are significant or quantifiable. In addition, we acknowledge that any observed outcomes may be attributable to factors and influences independent of our engagement activities.
We consider that the integration of sustainability risks in the decision-making process is an important element in determining long-term performance outcomes and is an effective risk mitigation technique. Our approach to sustainability provides a flexible framework that supports implementation across different asset classes and investment teams. While we believe that sustainable investing will lead to better long-term investment outcomes, there is no guarantee that sustainable investing will ensure better returns in the longer term. In particular, by limiting the range of investable assets through the exclusionary framework, positive screening and thematic investment, we may forego the opportunity to invest in an investment which we otherwise believe likely to outperform over time. Please see our ESG policies for details.
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The information in this material may contain projections or other forward-looking statements regarding future events, targets, management discipline or other expectations, and is only current as of the date indicated. The information in this material including statements concerning financial market trends, are based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. This material was prepared solely for informational purposes and does not constitute, and is not intended to constitute, a recommendation, professional advice, an offer, solicitation or an invitation by or on behalf of Manulife Investment Management or its affiliates to any person to buy or sell any security or to adopt any investment strategy, and shall not form the basis of, nor may it accompany nor form part of, any right or contract to buy or sell any security or to adopt any investment strategy. Nothing in this material constitutes investment, legal, accounting, tax or other advice, or a representation that any investment or strategy is suitable or appropriate to your individual circumstances, or otherwise constitutes a personal recommendation to you. Neither Manulife Investment Management nor its affiliates provide legal or tax advice, and you are encouraged to consult your own lawyer, accountant, or other advisor before making any financial decision. Prospective investors should take appropriate professional advice before making any investment decision. In all cases where historical performance is presented, note that past performance does not guarantee future results and you should not rely on it as the basis for making an investment decision.
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