How Real Estate Can Be Part of a Recession Investment Strategy

Editor’s note: This article has been updated with corrected data.

As the threat of a recession looms, many investors have decided that storing their money in cash and cash equivalents is a more attractive strategy than maintaining exposure to assets such as equities or private real estate. Instruments such as money market funds, high-yield savings accounts and short-term Treasury notes are currently offering yields upwards of 4%, a rate not seen for much of the past decade. But is there a more effective recession investment strategy than just parking your money and waiting it out?

According to many market observers—including us—the probability of a recession this year is high; economic indicators such as the inverted yield curve, a historical predictor of recessions, bear this out, and we are predicting a recession by October. We also have been taking this potential outcome into account in our Fund management. However, history shows that there are times, even in uncertain economic environments and periods of broader market downturns, where a willingness to take a risk with investment opportunities can have a bigger payoff. As private real estate Fund managers, we’ll demonstrate how investing in private real estate may be one such option.

Many Investors Have Cash to Invest but Are Risk-Averse

According to the Wall Street Journal and the Investment Company Institute, total assets in U.S. retail money-market funds reached a record level in late March. From Jan. 1 to March 29, such funds added roughly $196 billion in assets. That’s more than at any time since at least 2007. Even with cash to invest, it appears that these investors would rather avoid more unpredictable options such as the stock market or other asset classes and invest for a risk-free 4% return—either until rates change again or until they decide that it’s safe to go back in the water.

The reasoning behind this approach is clear. Investors in money-market funds, high-yield savings accounts and short-term Treasury notes take on zero risk for a predictable rate of return, albeit below the current rate of inflation. But there’s a challenge to this approach: There is no single economic condition that will signal the all-clear when it’s worthwhile to pivot back to a “risk-on” approach. Each investor’s decision to invest risk-free depends on external economic factors and myriad personal criteria including risk tolerance, financial goals and investing acumen. Investors who hide out for too long or attempt to “time the market” to their advantage may find they have lost valuable days, months—or years—by overlooking investments that can potentially deliver a premium over the risk-free rate.

Why Assets Like Real Estate Can Pay Off in Your Portfolio

Based on past returns, we believe that investors with a time horizon of seven or more years who are willing and able to shoulder a degree of risk can achieve returns of more than the risk-free rate over the long term. As you will see below, that can hold true during economic downturns and recessionary periods.

Cumulative Total Return, Private Real Estate Vs. 2-Year Treasury Notes

Note: 2-Year Treasury Note returns assume continuous reinvestment
and compounding of interest and principal payments.
Sources: NCREIF Fund Index—Open End Diversified Core Equity (NFI-ODCE) U.S. Department of the Treasury

The blue line in the chart above represents an investment in private real estate for the same period using the National Council of Real Estate Investment Fiduciaries’ (NCREIF’s) Open-End Diversified Core Equity Index for a proxy. NCREIF is a nonpartisan data service provider for the real estate investment community. This index is a capitalization-weighted index of private real estate funds, gross of fee, reflecting lower risk investment strategies that also utilize low leverage. Over this period, the investment strategy of rolling two-year Treasury notes produced an average annualized return of 3.24%. The real estate investment strategy produced a 7.57% annualized return (both are compounded).

How Time in the Market Can Build Return on Investments

As a recession investment strategy, there are more lucrative alternatives than rolling cash over for decades in short-duration Treasury notes. To be fair, most educated investors aren’t managing their entire nest eggs like this anyway. And putting money in a risk-free asset during a downturn is typically a shorter-term strategy. So, let’s focus on the historical returns if a person invested for seven-year periods beginning at the start of each recessionary period. In these cases, we are employing the recessions that have occurred since 1990 and comparing the rolling two-year Treasury notes strategy with private real estate.

Each seven-year investment period begins in January of the year in which the recession began, excluding the two-month recession in mid-2020 triggered by COVID-19 lockdowns—that is, 1990, 2001 and 2007.

7-Year Cumulative Total Return, 2-Year Treasury Notes Vs. Private Real Estate

Note: 2-Year Treasury Note returns assume continuous reinvestment and
compounding of interest and principal payments.
Sources: NCREIF, U.S. Department of the Treasury

In two out of the three most recent downturns, it would have paid to invest in private real estate. Two-year Treasury notes beat private real estate returns only during the early 1990s recession. However, on average over the three seven-year investment periods, private real estate generated a 5.9% annualized return for investors. That’s compared with 3.8% by the Treasury note strategy.

Average Annualized Return, Private Real Estate Vs. 2-Year Treasury Notes

Note: 2-Year Treasury Note returns assume continuous reinvestment
and compounding of interest and principal payments.
Sources: NCREIF, U.S. Department of the Treasury

Investing Beyond the Current Economic Cycle

Investors tend to consider real estate a commitment, holding real estate investments for more than seven years—sometimes much longer. That’s partly due to the illiquidity of private real estate. To account for this, the chart below conveys the same analysis over 10-year investment periods. In the 10-year cases, private real estate returns meet or exceed those of the two-year Treasury note strategy in all three major recessions. Over the three 10-year investment periods, private real estate generated average returns that exceeded those generated by two-year Treasury notes by a relative 68%.

10-Year Cumulative Return, Private Real Estate Vs. 2-Year Treasury Notes

Note: 2-Year Treasury Note returns assume continuous reinvestment and
compounding of interest and principal payments.
Sources: NCREIF, U.S. Department of the Treasury

No two economic downturns are exactly alike. A loss of consumer confidence and a jump in oil prices triggered the 1990 recession. In 2001, the dot-com bubble burst; and in 2007, it was securities backed by sub-prime mortgage loans. But as we show, over the long term, returns generated by a moderate private real estate investment have historically outweighed the associated risks. That’s true even during turbulent and declining markets.

You may believe the U.S. is headed toward a recessionary period. If so, you might be making investment decisions based on whether it pays to take on investment risk rather than following the flight to safety. Modern history suggests, on average, that taking the view of a long-term investor will pay off. In private real estate, we think beyond the next six months or year and play a longer game.

According to the numbers above, the game with the chances of a higher return outlasts the current economic cycle. We have found that, like us, most serious investors have a recession investment strategy that looks beyond the recessionary period. And they have long-term plans that don’t necessarily have to be derailed because of the current economic situation.