Improving DC outcomes with private core real estate

Our research illustrates that an allocation to private core real estate delivered potential benefits to DC plan performance during periods of market drawdowns. These benefits are especially relevant given the risk of a U.S. recession and the potential for value erosion in retirement portfolios.

In brief

  • Access to the strategic long-term benefits of private core real estate – stable income, low correlation to traditional asset classes, downside mitigation and the potential for inflation mitigation without increasing volatility – should not be restricted to defined benefit (DB) participants. Defined contribution (DC) plan sponsors are increasingly incorporating private core real estate into professionally managed participant portfolios.
  • In the post-COVID-19 environment, core real estate outperformed traditional asset classes over the one- and three-year time periods, by delivering total returns of 27.3% and 10.3%, respectively1.
  • Our research illustrates that an allocation to private core real estate delivered potential benefits to DC plan performance during periods of market drawdowns. These benefits are especially relevant given the risk of a U.S. recession and the potential for value erosion in retirement portfolios.
  • The benefits of private core real estate are rooted in its private market characteristics and its durable, predictable, steady income stream – a function of long-term leases with creditworthy tenants.
  • Our analysis indicates that while a modest allocation to REITs complements private core real estate, REITs alone have not exhibited the same portfolio-stabilizing and diversifying dynamics as those offered by private real estate.

Strengthening defined contribution participant outcomes

Defined contribution (DC) plans have become the foundation of retirement security for most members of the U.S. labor force, largely replacing defined benefit (DB) plans and shifting much of the investment decision-making and risk-taking to participants. The result: an increasing imperative for plan sponsors to offer participants a range of professionally managed, well-diversified DC solutions that can produce strong retirement outcomes across all market cycles.

The growth of target date funds (TDFs) and other professionally managed investment solutions, such as white label funds2, has helped plan sponsors address this imperative. But many DC plans are still missing an important component of DB plans – an allocation to private market assets, such as private real estate. DB plans, which have successfully implemented strategic real estate allocations for almost 50 years, currently have an average allocation of 9.5% (94% in private real estate, 4% in REITs and the remainder in private and public real estate debt)3.

In the early 2000s, custom TDFs were the first to incorporate the benefits of private real estate, while off-the-shelf solutions accessed their real estate exposure mainly via REITs. Today, the inclusion of both private real estate as well as REITs serves as a differentiator in off-the-shelf solutions.

We believe that lack of exposure to diversifying private market asset classes has contributed to the historical underperformance of DC plans relative to DB plans – which between 2000 and 2019 equated to 70 basis points (bps) of average annual underperformance and 190 bps of higher annual volatility. The result: lost retirement value for DC participants4.

Our analysis of prior drawdowns suggests that, within professionally managed solutions, an allocation to private core real estate, and a smaller allocation to REITs, can help close the DB-DC investment opportunity gap and strengthen participants’ retirement outcomes. This equates to a higher number of participants reaching their retirement goals, higher balances at retirement and the potential for more years of financial stability in retirement.

Diminishing opportunities for diversification and alpha in today’s public markets – coupled with a low growth, high inflationary environment – is making the inclusion of alternative investments like core private real estate essential, not optional, in participant retirement portfolios. During the last cycle, stocks and bonds delivered exceptionally strong performance while market volatility and inflation remained low. Today’s investing environment is more challenging.

As a result, we are seeing a growing number of DC plan sponsors taking advantage of the characteristics and benefits of private core real estate – enhanced diversification, stable income yields, stronger risk-adjusted returns, downside protection and better inflation mitigation.

Private real estate: a source of stability, diversification and inflation mitigation

The ability of private core real estate to augment the risk-adjusted returns of multi-asset portfolios while decreasing volatility is rooted in its income orientation, supporting its stable total return profile. The main drivers of real estate returns – supply, demand and capital market access – vary by geography and can be idiosyncratic. These micro-level, regional market drivers of real estate returns can differ from the more macro-level economic factors driving returns for equity and debt assets. This explains real estate’s relatively low correlation to these more traditional components of DC portfolios (Exhibit 1).

Long-term leases with creditworthy tenants are the source of the durable, predictable and steady income that insulates private core real estate’s total return in times of declining property valuations.

In addition, rent escalations in these leases contribute to protecting real returns, supporting the asset class as a potential inflation hedge. Core private real estate returns have generally outpaced inflation in periods of heightened inflationary pressures and longer-term periods of more normalized inflation (Exhibit 2). That benefit is especially important given that U.S. inflation is at a 40-year high.

U.S. private core real estate’s annual average income return of 5.7% over the past 20 years5 exemplifies the strength of its income component as a buffer for total returns during periods of depreciation. Further, most private real estate property types exhibit lower property revenue multiples, or betas, to economic activity than other asset classes. Space use tends to be among the least discretionary business spending items. Businesses may economize their space use during recessions but are usually limited in their ability to cut back real estate occupancy6.

The stable income return of private core real estate supports an overall return profile that is more consistently positive than that of other diversifying asset classes, such as REITs, commodities and U.S. TIPs. What’s more, its negative returns are less frequently coincident with those of a 60/40 stock-bond portfolio (Exhibit 3).

A blended core real estate solution can mitigate drawdowns and drive strong risk-adjusted returns for dc plan participants

Investment in private core real estate can help DC plan sponsors support stronger participant risk-adjusted returns and mitigate potential drawdown across glide path vintages. A DC participant’s portfolio would have benefited significantly during recent periods of market drawdown from the stable total return profile of such a core real estate allocation (Exhibit 4).

Our analysis suggests, however, that while public market REITs complement a private core real estate allocation, REITs alone have not exhibited the same portfolio-stabilizing and diversifying dynamics as private core real estate (Exhibits 1, 3 and 4). They have therefore not served as an ideal proxy for private core real estate.

While REITs remain an important part of overall portfolio construction, their public market orientation can lead to greater volatility in the shorter term compared with the relative stability of private core real estate – a derivative of its income and private market orientation. REITs reflect a smaller portion of the investible real estate universe, at 8% of total stock7, and have greater exposure to alternative property sectors – cellphone towers, for example – which can have different income and return drivers. REITs do serve as a complement to private real estate by offering daily liquidity, greater exposure to non-traditional property sectors and a degree of diversification over the longer term.

During recent periods of market stress, an allocation to private core real estate blended with a small allocation to REITs would have preserved value and supported relative return premiums across TDF vintages (Exhibit 5). Limiting portfolio volatility helps to minimize the pain of sharp market corrections for participants nearing retirement. For participants further from retirement, blended core real estate can provide an effective diversifier for TDFs with more distant target dates and the higher allocations to equities that make them more vulnerable to market drawdowns. Minimizing the magnitude and frequency of drawdowns can support stronger compounded portfolio value growth and risk-adjusted return over time.

In Conclusion

DC plan sponsors are stewards of their participants’ retirement health. With this responsibility in mind, they should consider investment options that address participants’ expectations and the risks that could impact retirement outcomes. In today’s challenging investing environment, market participants are rethinking portfolio construction. In particular, they are recognizing the need for the benefits of core private real estate – enhanced diversification, stable income yields, downside mitigation and better inflation mitigation – to enable stronger participant retirement outcomes.

As more and more DC plan sponsors include allocations to private real estate, the investment opportunity gap between DB and DC participants narrows. We expect this trend to continue as plan sponsors strive to provide their DC participants with what they deserve: well-diversified, professionally managed portfolios that drive stronger retirement outcomes.


1NCREIF Fund Index - Open End Diversified Core Equity (NFI-ODCE), net of fees; data as of June 30, 2022.
2White label funds are generically named funds that are branded by their asset class or objective.
3Institutional Real Estate and Kingsley Associates, 2022 Annual Institutional Investor Survey. The survey questionnaire was designed by Kingsley Associates and Institutional Real Estate, Inc. and administered as a web-based survey supplemented by interviews. A total of 200 responses were received.
4U.S. Department of Labor, Employee Benefits Security Administration, “Private Pension Plan Bulletin Historical Table and Graphs,” 2019.
5NCREIF Property Index, assets held within Open-End Diversified Core Equity funds; data as of June 30, 2022.
6“The Realization: DC asset allocation programs move beyond public markets,” J.P. Morgan Asset Management, 2013.
7NJ.P. Morgan Asset Management, NAREIT.