A look at co-investing in residential real estate
BY Yaelle Gang | May 30, 2019
For institutional investors looking to gain equity exposure to residential real estate, it comes along with a host of challenges. The ticket prices for homes are small, a lot of due diligence is required and managing a residential property is time-consuming.
Yet, it makes sense for institutional investors to be exposed to residential real estate, says Rayan Rafay, chief operating and chief financial officer at Unison, noting it’s one of the largest asset classes at roughly $162 trillion in value and is directly linked to the broader economy. “As it directly applies to the Canadian or the U.S. economy, it’s also the largest part of GDP. And then critically — and this is actually the hook for me coming from the plan sponsor side — is that it is far and away the largest piece of CPI or inflation.”
Rafay, who used to work as a plan sponsor, notes that actuaries look at plan liabilities and assets as a stream of coupon payments with duration, and so they pair with long duration bonds, which works well from a cash flow timing perspective but tends to ignore inflation risk.
“Inflation is actually a really big component of risk . . . whether you’re a foundation or endowment or pension plan, and there’s no way to directly hedge it. And so everyone’s doing these imperfect things — private debt, real estate, infrastructure — but we wanted to create something that gave pure inflation exposure,” he says, noting real estate makes up about 42 per cent of CPI.
Institutional investors can gain exposure to residential real estate using a co-investment model, notes Rafay. A 20 per cent down payment can be expensive for a homeowner, he adds, so an institutional investor can instead put in a portion of the down payment and then receive the option to share in the value of the house upon sale.
During the duration of the homeowners’ time in the house, they would manage upkeep of the property and pay down the mortgage. Then, upon sale, the investor would receive the payoff based on the change in value.
“The investor is getting property management for free and that’s one of the critical things that doesn’t allow residential real estate to scale,” Rafay says.
Unison is involved in co-investments both for those buying a home and for those who are sitting on home equity and want to sell some of it, he says.
Unison offers this co-investment option through an open-ended private real estate investment trust at scale and has used 70 years of mortgage data to predict how homeowners will act. It’s predictable, he says, noting if an investor has a large enough portfolio, roughly seven to eight per cent of homes will sell every year. “And so, I can’t tell you Mrs. Smith is going to sell her home, but I can tell you that 80 homes in the portfolio are going to sell every year.”
Typically, if pension plans make residential co-investments this way, it’s bucketed as a fixed income investment, Rafay says. “The investment mandates within a long core-plus mandate have become sufficiently wide that the way we’ve found the most traction is really saying, ‘Why would you go and invest in emerging market debt, an Argentina, a Brazil, an India, when you can actually go and invest in one of the most core assets, [what] we believe [is] the most core asset in an economy, and get the same returns or better?’ And that’s much more compelling, I think, we’ve found to fixed income people.”
He also notes this asset class has low correlations with equities and that housing performs well in all markets, including recessions, so is a good diversifier.
UPDATED: May 30, 2019 at 8:35 a.m.