On the flip side, property values are down by about 15% to 25%, especially in areas like the office space sector, says Paul Daneshrad, the CEO of Starpoint Properties, a firm that manages real estate through pooled investments. Those values are expected to recover in the next couple of years as the Fed reduces interest rates, he said.
Daneshrad has been a real-estate investor for over 35 years. His firm's strategy has been centered on opportunities that generate alpha, which means gains that beat the stock market. He's also looking for asymmetrical returns, which implies the upside outweighs the downside risk.
"So if the S&P is going to deliver an eight or a 10% return in a given year, we're going to try to deliver a 15% to 20%," Daneshrad said. "If the S&P or the Dow is going to deliver a 12%, we're going to try to deliver at 20% or 25%, and we're going to try to do that tax-advantaged so that there's even a higher return."
The firm's highest risk category is the opportunistic strategy, which began in 2002 and is a combination of funds and individual properties that make up a mix of apartment and retail buildings that were below market value and underwent either major renovations, expansions or development. Its annual internal rate of return has been 51% to 2022. The S&P 500 returned 8.14% over the same period. The firm's opportunity zones strategy is a makeup of development projects in areas that need funding. Its annual internal rate of return is 14% to 16%. However, because it takes advantage of a Federal Program, profits are tax-free, but the primary investment must be from other sources of capital gains.
Real-estate funds are a great alternative for investors looking to diversify their retirement portfolios without buying and managing property because they're not correlated to the stock market. They also have an element of organic growth where demand will increase over time, and so will the value of properties, he said.
"Most real-estate rents, whether it's an industrial or an apartment or an office building or a retail project, have annual increases in their leases," Daneshrad said. "So every year, their rent goes up automatically by 3% to 3.5%. So there's that compounding growth within it."
Depending on the fund's setup, those who invest their cash may be given payouts from rents and can profit when a property is sold, he noted.
Despite a pullback in housing activity in 2023, home prices continued to rise, up by 5.5% year-over-year in December, according to CoreLogic. On the other hand, commercial real estate has faced a reckoning and is expected to be volatile over the next few years. Office space values in some areas have plunged as work-from-home trends persisted past pandemic-era lockdowns.
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Like any investment, there's always a risk. Daneshrad cited three: recessionary fears, which could impact tenants' ability to pay rent; elevated interest rates, which increase the cost of servicing debt; and the risk that projects will fail.
He suggests picking funds focused on sectors that are expected to outperform. These include those investing in data centers or infrastructure spending backed by government contracts. Ideally, a firm should have a long and successful track record of delivering returns over 20 years. The management team must have direct real-estate experience and capital in the fund. Finally, the fund should not be over-leveraged, with a loan-to-value ratio below 60%.
Investing without owning
Like real-estate investment trusts (REITs), real-estate funds provide exposure to the tangible asset class without owning and managing property. However, REITs are accessible on a stock exchange. Investing directly through a private real-estate fund would take a few extra steps.
Generally, returns from investments are classified as capital gains and have a lower tax rate than income, especially for those in a high tax bracket. But there is another layer that can reap further tax advantages, and it's done by utilizing Roth or Traditional IRAs, Daneshrad noted.
If you have cash or stocks in a Roth or traditional IRA, you can use some of that to invest in a real-estate investment fund. But you may need to do it under the guidance of a CPA so you don't unknowingly trigger a tax event, he noted.
"The best way to get those alpha returns for a 9-to-5 person is to set up your RIA or Roth, start putting money into that every month, have that start investing so it gets capital gains treatment down the line, and then invest that money into areas where people are going to see real growth and allow that compounding," Daneshrad said."
The process requires an investor to identify a real-estate fund of interest. The firm that owns the fund would then send documents to sign in the name of your Roth or IRA account, Daneshrad said. Once that's completed, funds from the retirement account are directly transferred into the real-estate fund. Not every fund qualifies for this process, and it's important to determine which funds can receive IRA money, he noted.
Gary Diamond, a CPA and managing partner at Fishman, Block + Diamond, says you need to set up a self-directed IRA (SDIRA) if you plan on doing this. This means it's not managed by a third party. A 401(k) would not qualify unless rolled into an IRA first.
Some of those gains can then be transferred into real-estate assets. Daneshrad recommends only allocating a portion of an IRA to remain diversified.
Diamond added that since an investor won't own property directly, they can't claim deductions for property taxes, mortgage interest, depreciation, and other property-related expenses that landlords can. It's also important to read the terms of each fund; some may have added costs for repairs, expenses, and maintenance, which your IRA funds would cover.
