Core and core-plus real estate: Enhancing diversification in institutional portfolios

October 14, 2024 | 7 min read

Art Jones

Senior Director, Global Real Estate Research and Strategy

Todd White

Managing Director, Portfolio Management

Kyle Elfers

Managing Director, Portfolio Management

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The commercial real estate market has been in recession since central bankers began increasing interest rates in 2022 to combat inflation. Investors, for their part, have been forced to reevaluate their portfolio strategies and are poised to reenter the market as policy shifts towards a more favorable capital market environment. We believe that commercial real estate investors will have the opportunity to re-engage in the transaction market across a broad risk spectrum and take advantage of more opportunistic pricing as the global real estate recovery takes hold.

Since 2022, both core and core-plus real estate have undergone significant repricing as higher interest rates have slowed investment activity and created pockets of distress within investor portfolios. Property values, according to the NFI-ODCE index, have fallen by 24% across all sectors—led by the struggling office sector—but declines have negatively affected all sectors, including apartment and industrial, which have remained favored by most institutional investors (Exhibit 1). We feel that a sustained growth environment, combined with more accommodating interest rates and significant re-pricing of real estate assets, provides an opportunity to generate attractive returns through a combination of income and growth.

EXHIBIT 1: Commercial real estate assets have been repriced and may offer attractive returns
Property sector capital values, Peak to current %

*Reflects correction beginning in 2022, retail commercial real estate values are 25.4% below their peak established in 2017.
** Reflects correction beginning in 2022, retail commercial real estate values are 28.6% below their peak established in 2015.
Source: NCREIF NFI-ODCE Principal Real Estate Q2 2024.

Over the past 45 years, the NFI-ODCE has recorded negative total returns in only five calendar years: 1990, 1991, 2008, 2009, and 2023. Following the first two corrections—both of which were associated with recessions—the benchmark went on to achieve 15-year and 13-year spans of positive total returns. During these recovery periods, annual total returns averaged 11%.

What is different this time, is the lack of underlying economic stress. The correction in real estate values was driven purely by capital market stress created by higher interest rates, which corresponded to a period of strong economic performance. One benefit of higher interest rates is the depressing effect it had on new development, which has already begun to have a positive impact on overdeveloped sectors like apartment and industrial and we believe it will continue to benefit investors well into 2025.

While history does not always repeat itself, we believe that with sustained economic growth and more accommodative interest rates, real estate is poised to enter another period of positive returns, which will benefit both core and core-plus strategies.

The approach to core and core-plus

Private equity real estate investments tend to be categorized based on the risk-return profile of the underlying investment strategy:

Core: This is the foundation of most institutional real estate portfolios, focusing on high-quality, stabilized assets with occupancy rates in the 90% range. The low-leverage strategy targets assets and markets that generate most of their return from stable income yields over the holding period. Core strategies tend to own property in established infill locations with competitive attributes and modern specifications, and portfolios tend to have exposure to major cities driven by well-educated workers and high-value-added industries, providing investors with structural growth drivers over the life of their investment.
Value-add: Tends to take on more risk, including leasing and capital improvements, which may generate higher returns and capital gains.

Opportunistic: Carries the highest risk-return potential, generated mostly from capital gains. It often includes development and leasing risk.
Core-plus: As the name suggests, core-plus focuses on investments that fall within the lower end of the risk-return spectrum but can also capitalize on value-add and development opportunities to enhance total returns. This strategy typically focuses on maintaining 60% to 80% of gross asset value in stable, income-producing core assets, while pursuing value-add and development opportunities with 20% to 40% of assets. Core-plus strategies also use a moderate amount of leverage (typically 35% to 50%) to achieve higher returns.

Core-plus in the current environment

Given the mature nature of the recent period of price discovery, core-plus offers an attractive entry point for investors:

Lower interest rates ahead: Commercial real estate, among risk assets, has been penalized by elevated interest rates due to a less accommodative central bank policy. As a result, the sector has been in recession over the past two years, despite healthy operating fundamentals. More recently, policy has shifted, which could support more robust and stable economic growth as capital costs for businesses are reduced. For core-plus real estate, stronger demand as well as the ability to reduce cap rates and maintain more favorable spreads could be highly accretive to attractive returns through both appreciation and income returns. A well-executed core-plus strategy will result in a steady income stream in our view and lower interest rates in the near term should help provide opportunities to generate greater returns through the prudent use of leverage.
Tactical advantage: Core-plus strategies are less constrained by traditional benchmarks, allowing more tools to generate higher returns. While leverage has been challenging in the current environment, a lower interest rate environment should benefit core-plus investors. Desirable properties are trading below replacement cost, and with elevated debt maturities on over levered capital structures, distress will create unique opportunities as liquidity constrained investors seek exit strategies. Well-capitalized core-plus investors can take advantage of discounted pricing and sell into healthy tenant and investor demand within most property sectors.
Benefits of private real estate: Both core and core-plus strategies benefit from low correlations with other risk assets, historically stable returns, and protection against inflation due to strong income returns. Several core-plus strategies are also available in an open-ended fund format, which is attractive for investors, given the relative ease of redemption compared with individual properties or closed-end funds.

Why core real estate funds?

Income stability and growth: Private equity real estate has earned a well-deserved reputation as an effective inflation hedge. While the last two years have been an outlier, this is more an anomaly than a rule. The income component of property returns is remarkably stable, outperforming inflation by 328 basis points on an average annual basis since the inception of the NCREIF NPI. High-quality assets in top-tier markets allow core real estate portfolios to maintain healthy income returns that provide stable long-term returns with lower volatility, even during periods of higher market uncertainty.
Tactical opportunities: Although core real estate’s appeal has long been its ability to provide durable income returns for investors, in today’s environment the strategy also offers the potential for healthy returns on capital. Lower interest rates coupled with attractive valuations today offer investors interested in adding core real estate to their portfolios an attractive entry point.
Systematic economic exposure: Core real estate funds have the unique advantage of exposure to economic drivers within the largest and most vibrant metro areas. This exposure is unavailable to individuals investing in single properties, offering increased diversification, long-term appreciation potential, and lower risk than other risk assets. As part of a diversified portfolio, core real estate may offer some of the highest risk-adjusted returns, aiming to enhance returns through diversity and income stability.
Growing diversity: In addition to regional diversity, core real estate also offers sectoral diversity. The NPIODCE has seen dramatic shifts in its asset allocations, most notably away from the office and retail sectors in recent years and toward alternative sectors traditionally associated with publicly listed REITs. Open-ended funds now hold a significant allocation to non-traditional sectors (including data centers, self-storage, life science, medical office, student housing, manufactured housing, age restricted housing, and single-family rentals), and that allocation is expected to grow, providing access to emerging growth areas while maintaining the stability of core assets, such as industrial, apartments, and retail.

Institutional quality and emerging opportunities

As global economic growth is anticipated to stabilize and expand, commercial real estate is poised to recover following a difficult period of pricing correction. Investors should consider core and core-plus strategies to enhance their real estate portfolios. Under normal circumstances, core real estate could be viewed as a more conservative approach. However, we believe the market is poised for a moderate increase in valuations as central banks ease upward pressure on interest rates, reducing current bid-ask spreads. Core portfolios will continue to offer solid income performance with the potential for increased capital value growth throughout the recovery.

Core-plus investors, meanwhile, will look for emerging opportunities and use debt to enhance portfolio returns through stable income—secured by institutional-grade real estate—while taking advantage of favorable pricing. These strategies also offer increased liquidity through open-ended funds, absent in most opportunistic funds. We believe core-plus strategies will continue to offer favorable risk-adjusted returns for investors seeking to improve their portfolios and increase real estate allocations.

Real estate

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Information in relation to the Principal Global Investors Funds is available through this web site to institutional investors resident in the following countries of: Belgium, France, Finland, Germany, Guernsey, Ireland, Italy, Jersey, Netherlands, Spain, Sweden, Switzerland and the United Kingdom. By proceeding this far you are representing and warranting that you are an institutional investor resident in one of these countries. Not all of the Funds are available in all these jurisdictions, and investors are directed to the Country Registration document for detailed information. What follows is not an offer or invitation to acquire an investment to, and should therefore not be relied upon by, any person anywhere other than the countries noted. Persons in respect of whom such prohibitions apply must not access this web site. This web site is reserved exclusively for non-U.S. persons and should not be accessed by any person in the United States.

Yes, I certify to be an institutional investor and resident of a country listed above.

Cookies
Use of cookies on this site is outlined in the Privacy and Security Policy. In accepting these terms and conditions, you accept the terms of the Cookie Policy and the use of cookies from this site.

Legal Entity Disclosure and Regulation
In Europe by Principal Global Investors (Ireland) Limited, 70 Sir John Rogerson’s Quay, Dublin 2, D02 R296, Ireland. Principal Global Investors (Ireland) Limited is regulated by the Central Bank of Ireland.

In the United Kingdom by Principal Global Investors (Europe) Limited, Level 1, 1 Wood Street, London, EC2V 7 JB, registered in England, No. 03819986, which is authorised and regulated by the Financial Conduct Authority (“FCA”).

In Switzerland by Principal Global Investors (Switzerland) GmbH. This website is considered as advertising and information contained herewith be treated as such. Investors can obtain free of charge the prospectus, trust deed, the prospectus, the key investor information document (KIID), and the annual and semi-annual reports from the representative in Switzerland.

In Europe and United Kingdom, this website is directed exclusively at Professional Clients and Eligible Counterparties and should not be relied upon by Retail Clients (all as defined by the MiFID and FCA respectively). If you are viewing the material as a retail investor, you should seek independent investment advice before deciding whether the products and services in question are suitable to meet your investment needs and objectives, as the language has not been complied to a retail client standard.

Principal Global Investors Funds
Principal Global Investors (Ireland) Limited is the issuer of the Funds. Investments may only be made on an application form attached to a current prospectus and following receipt by the investor of the KIID in respect of the Fund in which they intend to invest. The latest version of the prospectus of the Funds is dated 14 December 2012.

For Real estate investors in the European Economic Area (“EEA”), this website and the information on it is only directed at persons who are professional investors for the purposes of the Alternative Investment Fund Managers Directive (2011/61/EU) (“AIFMD”), professional clients or eligible counterparties for the purposes of the Markets in Financial Instruments Directive (Directive 2014/65/EU) (“MiFID II”) or as otherwise defined under applicable local law and regulation and at whom this website and the information on it may lawfully be directed in any relevant jurisdiction (“Eligible Persons”). In relation to each member state of the EEA (“Member State”) which has implemented AIFMD (and for which transitional arrangements are not/ no longer available), this website may only be accessed and interests in Funds may only be offered or placed in a Member State to the extent that: (i) the relevant Fund is permitted to be marketed to professional investors in the relevant Member State in accordance with AIFMD (as implemented into the local law/regulation of the relevant Member State); or (ii) this website and its information may otherwise be lawfully distributed and the interests in Funds may otherwise be lawfully offered or placed in that Member State (including at the initiative of the investor). In relation to each Member State of the EEA which, at the date of accessing this website, has not implemented AIFMD, this information may only be distributed and interests in Funds may only be offered or placed to the extent that this information may be lawfully distributed and the interests in Funds may lawfully be offered or placed in that Member State (including at the initiative of the investor).

Persons who are not Eligible Persons, including but not limited to those individuals or other persons who fall within the FCA’s definition of ‘retail clients’, should not use or rely upon this website or the information contained therein and may not engage the services of Principal Real Estate or any of its affiliates, or invest in any Fund. Potential investors are advised that all or most of the protections provided by the UK regulatory system will not apply and that the UK Financial Services Compensation Scheme may not be available in relation to an investment in a Fund or separate account.

The contents of this website have not been verified or approved by any competent regulatory or supervisory authority. No liability, whether in negligence or otherwise, arising directly or indirectly from the use of the information or any part of it on this website is accepted and no representation, warranty or undertaking, whether express or implied, is or will be made at any time by Principal Real Estate or its affiliates or any of their respective advisers, directors, officers, employees, representatives or other agents (“Principal Agents”) for any information or any of the opinions contained herein or for any errors, omissions or misstatements.

None of Principal Real Estate or its affiliates or any Principal Agents makes or has been authorised to make any representation or warranties, whether express or implied, in relation to Principal Real Estate or regarding the truth, accuracy or completeness of any of the information contained on this website at any time. No representation or warranty is given by Principal Real Estate, its affiliates or the Principal Agents as to the achievement or reasonableness of, and no reliance should be placed on any projections, targets, estimates or forecasts contained in the information on this website. Furthermore, nothing contained on this website is or should be relied on as a promise or representation as to the future. No reliance may be placed by any person for any purpose whatsoever on the information or opinions contained on this website or on its completeness, accuracy or fairness at any time.

Principal Global Investors (Europe) Limited is not authorised by the FCA to directly deal with retail investors; any distribution of the Fund to retail investors in Europe is facilitated by fund distributors with which Principal Global Investors (Europe) Limited has entered distribution arrangements, pursuant to advice provided to investors by those distributors, based on the documents Principal Global Investors (Europe) Limited provides. Retail investors should not be provided with access to this website.

The name of the Swiss representative is ACOLIN Fund Services AG, Stadelhoferstrasse 18, CH-8001 Zürich. The name of the Swiss paying agent is Banque Cantonale de Genève, 17, quai de l’Ile, 1204 Geneva. Investors can obtain the prospectus, trust deed, the simplified prospectuses and the annual and semi-annual reports free of charge from the representative in Switzerland.
The value of units and the income from them may fall as well as rise.

Investments in the Funds are neither insured nor guaranteed by the US Government or the Federal Deposit Insurance Corporation and are not deposits or obligations of, or guaranteed by, Principal Global Investors.

No Solicitation
Nothing contained in this website shall constitute an offer or solicitation, in relation to units in the Funds or generally, in any jurisdiction or in any circumstances in which such offer or solicitation is unlawful or not authorised.

In particular, shares issued by the Company, and units in the Funds, have not been and will not be registered under the United States Securities Act of 1933 as amended or the securities laws of any state or political subdivision of the United States and may not, except in a transaction which does not violate US securities laws, be directly offered or sold in the United States or to any US Person. The Company will not be registered under the United States Investment Company Act of 1940 as amended.

This website is reserved exclusively for non-US persons and should not be accessed by any person in the United States.

No Investment Advice
The information in this website contains general information only on investment matters and should not be considered as a comprehensive statement on any matter and should not be relied upon as such nor should it be construed as specific investment advice, an opinion or recommendation. The general information it contains does not take account of any investor’s investment objectives, particular needs or financial situation, nor should it be relied upon in any way as a forecast or guarantee of future events regarding a particular investment or the markets in general. Past performance is not a reliable indicator of future performance and should not be relied upon as a significant basis for an investment decision.

You should also inform yourself as to (a) the possible tax consequences, (b) the legal requirements and (c) any foreign exchange restrictions or exchange control requirements which you might encounter under the laws of the countries of your citizenship, residence or domicile and which might be relevant to any investment, including the subscription, holding, transfer or disposal of units in the Funds

Delegation of Investment Management to Affiliates

Products upon which composite results contained in this material, if any, are based may not themselves be available in the United Kingdom and certain other jurisdictions; however, the underlying investment management capability can be made available to institutional investors subject to all applicable local regulations and restrictions. In connection with its management of client portfolios, PGIE may delegate management authority to affiliates that are not authorised and regulated by the Financial Conduct Authority. In any such case, the client may not benefit from all protections afforded by rules and regulations enacted under the Financial Services and Markets Act 2000.

Disclaimer
The information on this website is given by Principal Global Investors in good faith and has been derived from sources believed to be reliable and accurate as at their date. However, Principal Global Investors makes no representation or warranty of any kind for the accuracy or completeness of the information and it is under no obligation to update or correct any errors in the information after the date of publication. This website also contains videos where the comments were valid on the date the video was recorded. Markets move continuously and you should only rely on current information for any investment decisions.

Subject to applicable law, Principal Global Investors and its affiliates and their respective directors, employees and associates do not accept any responsibility arising in any way (including by reason of negligence) for errors in, or omissions from, the information and do not accept any liability for any loss or damage, however caused, as a result of any person relying on any information on the website or being unable to access the website.

The Internet is not a totally reliable and secure medium of communication. Principal Global Investors accepts no liability for the security or confidentiality of information transmitted in this way and any such transmission of information shall be at your own risk.

The entire content of this website is subject to copyright with all rights reserved. You may not copy, reproduce, distribute or modify the content of this website without the prior written permission of Principal Global Investors.

No instructions for investment purposes will be accepted directly from this website or by e-mail.

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You may view, download for caching purposes only, and print content from the website for your own personal use, subject to the restrictions set out below and elsewhere in these Terms of Use.

No Guarantee of Timeliness
This website may contain videos where the comments were valid on the date the video was recorded. Markets move continuously and you should only rely on current information for any investment decisions. The information and materials contained on this website, and the terms, conditions, and descriptions that appear, are subject to change. All content on this website is presented only as of the date published or indicated, and may be superseded by subsequent market events or for other reasons. In addition, you are responsible for setting the cache settings on your browser to ensure you are receiving the most recent data.

No Warranties
The information on this website has been developed internally and/or obtained from sources believed to be reliable; however Principal Global Investors and its affiliates do not independently verify or guarantee its accuracy or validity. The information and services provided on this website are provided ""AS IS"" and without warranties of any kind, either expressed or implied. To the fullest extent permissible pursuant to applicable law, Principal Global Investors disclaims all warranties, including, but not limited to, any warranty of non-infringement of third-party rights and any implied warranties of merchantability and fitness for a particular purpose. Principal Global Investors does not warrant, either expressly or impliedly, the accuracy or completeness of the information, text, graphics, links or other items contained on this website and does not warrant that the functions contained in this website will be uninterrupted or error-free, that defects will be corrected, or that the website will be free of viruses or other harmful components. Principal Global Investors expressly disclaims all liability for errors and omissions in the materials on this website and for the use or interpretation by others of information contained on the website. Subject to any contrary provisions of applicable law, no company in the Principal Financial Group nor any of their employees or directors gives any warranty of reliability or accuracy nor accepts any responsibility arising in any other way (including by reason of negligence) for errors or omissions on this website.

If you have questions, please email us.

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This website contains general information only on investment matters and nothing in this website is intended to constitute or form part of any offer or inducement to issue or sell, or any solicitation of any offer to subscribe for or purchase, any securities or investment products in the UAE (including the Dubai International Financial Centre) and accordingly should not be construed as such. Information in this website is not directed at you if we are prohibited by any law of any jurisdiction from making the information on this site available to you and is not intended for any use that would be contrary to local law or regulation. Products or services mentioned on this site are subject to legal and regulatory requirements in applicable jurisdictions and may not be available in all jurisdictions. Accordingly, persons are required to inform themselves of and observe any such restrictions.

The information in this website is being made available on the basis that the recipient acknowledges and understands that the entities and securities to which it may relate have not been approved, licensed by or registered with the UAE Central Bank, the Dubai Financial Services Authority or any other relevant licensing authority or governmental agency in the UAE or elsewhere in the Middle East.

The information in the following website should not be construed as investment advice or a recommendation for the purchase or sale of any security. The value of investments and the income from them may fall as well as rise. Principal Investor Management (DIFC) Limited and the other member firms of Principal (collectively, the “Firms”) do not guarantee any investment results and there can be no assurance that the strategies employed will improve investment performance, and make no guarantee that a client’s investment objectives will be achieved and no warranties or representations, expressed or implied, are made by the Firms concerning the benefits of these strategies discussed herein. The information in this website has been developed internally and/or obtained from sources that the Firms believe to be reliable; however, the Firms do not guarantee the accuracy, adequacy or completeness of such information and are not responsible for any errors or omissions. This website also contains videos where the comments were valid on the date the video was recorded. Markets move continuously and you should only rely on current information for any investment decisions.

This website contains general information only on investment matters and should not be considered as a comprehensive statement on any matter and should not be relied upon as such. The information it contains does not take account of any investor’s investment objectives, particular needs or financial situation. Past performance is not a reliable indicator of future performance and should not be relied upon as a significant basis for an investment decision. You should consider whether an investment fits your investment objectives, particular needs and financial situation before making any investment decision.

Nothing in this website should be construed as investment, tax, legal or other advice.

The content of this website has not been approved by or filed with the UAE Central Bank or Dubai Financial Services Authority.

Access to this website is only permitted for “Professional Clients” as defined in the Conduct of Business of the Dubai Financial Services Authority’s Rulebook. If you are not a “Professional Client”, you may not access this website and you should select the “Decline” link below.

By selecting the “Accept” button below, and entering this website, you agree to these terms and confirm and represent that you are a “Professional Client”.