Real Estate

The Real Estate asset class includes both residential real estate as well as commercial real estate (CRE). Commercial Real estate has several subsectors including Office, Multi-family, Retail, Healthcare and Industrial. We’ll start by looking at historical and project returns for residential real estate and then analyze historical and projected returns for commercial real estate.

Unfotunately there is less publicly available data for Real Estate than for Equities and Fixed Income. This is due to the fact that many real estate transactions are private, for both residential and commercial real estate, as well as the fact that maintenance and other capital expenditures are not reported, and much be estimated to determine historical returns. Real Estate is a massive asset class with U.S. residential real estate estimated to be valued at $33.6 trillion as of early 2020. U.S. commercial real estate was estimated to be valued at $14.4 to $17 trillion as of the end of 2018.

Historical returns-Residential Real Estate

Real estate returns are driven by price appreciation or depreciation plus rental income minus maintenance expense. In terms of residential Real Estate prices, Robert Shiller and Karl Case publish a robust data set of U.S. home prices dating back to 1890. Their data indicates that nominal U.S. home prices increased by 3.2% per year from 1890-2019, but only 0.44% per year after adjusting for inflation. Using that same data set, from 1960-2019 U.S. home prices appreciated by 4.6% on a nominal basis and 0.8% on a real basis. After adding an estimated gross rental yield of 5% and subtracting annual capex of 2%, the total nominal return on U.S. residential real estate was 7.6% and 3.8% on a real basis from 1960-2019.

However, home price appreciation in the U.S. has been stronger recently, averaging 3.5% real price appreciation per year over the past 5 years and 2.4% per year over the past 10 years. Additionally, there are several cities listed below where prices appreciated well above the national average over the past 5 and 10 years. The higher home price appreciation over the past decade is likely due to record low mortgages rates as a result of low interest rates, which reduce the cost of buying, with home ownership rates increasing over the past decade as a result.

U.S. Real Home Price Index 1890-2019

real home price index

Source: Robert Shiller’s website

U.S. Real Price appreciation past 5 and 10 years

 real home price index

Source: S&P Global

Projected returns-Residential Real Estate

As noted above total real estate returns are driven by price appreciation or deprecation plus the rental yield minus capex. Given that U.S. residential real estate has barely appreciated above the rate of inflation over the past 129 years, that seems to be a reasonable estimate going forward as well. I estimate an annual total return for U.S. residential real estate of 2% nominal appreciation plus a 5% gross rental yield minus 2% capex, giving a 5% nominal return and 3% real return assuming 2% annual inflation.

Residential real estate returns is very much a localized market, with urban home prices having increased well above the national average in many cities over the past decade. It’s too early to tell how COVID-19 will impact demand for residential real estate in urban areas, but we are likely to see increased demand for lower cost areas as well as for suburban and rural areas given my expectation that more companies will opt for increased use of remote work to attract a more diverse employee base and to cut down on expenses. As a result, I expect total returns for urban real estate are likely to lag total returns for suburban and rural areas.

Historical Returns-Commercial Real Estate

Turning to commercial real estate, NCREIF provides private commercial real estate returns going back to 1978, while returns for publicly traded REITs goes back to 1972. Although this is not as long a history as for Equities or Bonds, the data gives us a decent sample size through a variety of economic environments. However, there are some challenges with the data as the NCREIF data shows appraisal-based returns which are excessively smoothed and often stale. The smoothing effect understates how volatile returns can be, which boosts the Sharpe ratio (Returns/Standard Deviation) as a result.

Additionally, the NCREIF data likely overstates the actual returns investors would receive due to taxes, fees, and other expenses. However, the REIT data is cleaner as REIT’s are publicly traded entities, so returns for REIT’s reflect actual market prices. To qualify as a REIT, an entity must generate 75% of their revenue from rental income and must pay a minimum of 90% of their taxable income in the form of dividends every year, to receive preferential tax treatment. The chart below compares the NCREIF property index with the REIT Total Return Index and S&P 500 Total Return index over the past 40 years. Given that the NCREIF Index likely overstates total returns, Private Commercial Real Estate looks to be much less attractive than Public Commercial Real Estate (DJIA REIT Index) or U.S. Equities (S&P 500 Index), as an asset class over the past 40 years.

real home price index

Projected returns-Commercial Real Estate

Over the long-term commercial real estate returns are driven by: Income (cap rate-capex), income growth (expected long-run inflation) and expected value change. The cap rate represents operating income/price of property, and operating income is driven by rent minus maintenance and operating expenses. From a valuation perspective we can compare the cap rate on commercial real estate to dividend yields for equities or yields for bonds. While returns have historically been attractive for commercial real estate as shown above, the consensus outlook for the asset class is extremely negative given the unprecedented impacts of COVID-19. Of the major CRE categories (office, multi-family, healthcare, industrial, retail), we are observing substantial weakness across office, retail, and healthcare while multi-family and industrial should perform better. What follows does not constitute an investment recommendation but instead describes some of the key trends facing the major CRE sectors.


The retail subsector was already facing structural headwinds from the shift towards e-commerce as shown below. E-commerce sales as a percent of total retail sales have increased from roughly 4% to 12% over the past decade and are expected to increase further driven by quarantines and convenience factors.

real home price index

Source: Census Bureau

Additionally, many retailers have withheld rent from landlords such as Gap, PetSmart, and L Brands, while others have filed for bankruptcy such as J. Crew, Neiman Marcus, JC Penney, and Hertz.

Even prior to COVID-19, the retail footprint in the U.S. is vastly overbuilt relative to Europe and Japan with roughly 24 square feet per capita, 40% more than Canada and nearly 5 times as much as other developed countries such as the UK, Japan, and France. As a result, rent collections were at 79.4% for Free Standing retail and only 60.5% for Shopping Centers compared to normal collections as of June 2020.


To date rent collections have been strong in the mid-90%’s for Office REIT’s, given that many tenants have long-term leases in place. However, a recent report noted that Manhattan rents could decline 26% in a prolonged recession, bringing rents back to the levels they were at 2012. This is being driven by the rise in remote work due to COVID-19. Remote working had been on the rise for several years but only accounted for 5% of U.S. employment in 2017. As of April 2020, 50-60% of Americas were working from home. Prominent companies including Facebook, Twitter, Microsoft, JPMorgan, Morgan Stanley, Amazon, PayPal have all extended remote working as an option for employees. As a result, I expect the leasing environment for commercial office space to be extremely weak going forward as major office tenants plan to reduce their office footprint to save costs and to minimize risks associated with COVID-19.


Historically, multi-family has been considered one of the less cyclical CRE sectors due to the strong demand for housing. Many states and municipalities have enacted emergency housing measures which should stabilize the sector in the short-run and tenants are also benefitting from the fiscal stimulus package which includes enhanced unemployment benefits as well as a one-time check of $1200 for many individuals. As a result, rent payments remain strong with a recent National Multifamily Housing Council (NMHC) report noting that 92% of apartment households made a full or partial rent payment by June 20th based on their survey of 11.4 million units.1

However, the sector is still challenged given substantial unemployment and job losses. The expanded unemployment benefits sunset at the end of July, and absent additional fiscal stimulus, the sector will face difficulties in the near-term. Over the longer term, the sector should see strong demand as homeownership rates remain low, although it is difficult to tell what will happen with regard to demand for buying versus renting given near record low interest rates at the moment. Demand for suburban housing will likely increase offset by weaker demand for urban housing, reversing the trend of the last decade.


Industrial REIT’s own and manage industrial facilities such as warehouses and distribution centers and have benefited substantially from the rise in e-commerce described above. The sector should continue to benefit from increased e-commerce volumes going forward. Additionally, direct impacts from COVID-19 should be less so than other sectors, as industrial REIT’s do not interface with the public, and rent collections remain strong at 97.8% through June, 2020.

Gaining exposure to Commercial Real Estate:

There are a variety of ways to gain exposure to commercial real estate. et exposure to real estate outside of one’s primary resident. You could purchase a multi-family building, which may an attractive option to generate relatively stable “passive income”. Additionally, you can gain exposure through REIT’s which are publicly traded, or through private commercial real estate which is typically only available to accredited investors. For REIT’s you can purchase shares in individual REIT’s such as SPG, PLD, or BXP, or in an index covering either a REIT subsector or the entire REIT universe.

Another, more recent option is the proliferation of crowd-funded real estate. These platforms are available for both accredited and non-accredited investors and offer investors the ability to invest directly in either the debt or equity of commercial real estate projects. The most popular crowd-funded sites are: Fundrise for non-accredited investors and CrowdStreet for accredited investors. FarmTogether is another crowd-funded site focused exclusively on investing in farmland.

While these sites generally offer attractive returns, there are at least two concerns I have with these platforms. One returns have generally been declining over the past few years, which makes sense given the declining interest rate environment. Additionally, these sites have largely not been tested in a recessionary environment as most were launched since the Financial Crisis. As a result, it’ll be interesting to see what impact COVID-19 has on the returns of projects on these platforms. We may start to see some attractive return opportunities on these sites as a result. In full disclosure, I have not currently invested on these sites, largely due to the illiquidity, fees, and limited historical returns. But they may be an attractive asset class diversifier, depending on your specific situation.


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