401(k) real estate investing: How DC plans can learn from DB plans

A new analysis from J.P. Morgan says that defined contribution (DC) retirement plans should look more closely at private core real estate for their portfolios. The report said DC plan sponsors are increasingly incorporating private core real estate into professionally managed portfolios.

The study noted that defined benefit (DB) retirement plans have successfully implemented real estate investments for almost 50 years, and currently have an average allocation of 9.5% on average, nearly all (94%) in private real estate.

Jani Venter, an executive with J.P. Morgan’s Defined Contribution Fund Management Team and author of the report, said that DC plans are increasingly looking to private real estate as part of a diversified portfolio. “Private real estate and the benefits associated with the asset class is part of a long-term strategic allocation to support stronger retirement outcomes,” Venter said. “With the benefits private real estate demonstrated post-COVID through Q3 2022 alone, we’re seeing increased interest and adoption.”

A hedge in recessionary times

One of the points of the paper is that at a time of economic uncertainty, real estate is a stable, predictable area of investment for retirement plans. The report said that the lack of diversification of private asset investments may be a reason that DC plans have historically underperformed when compared to DB plans.

With the current talk of a recession, the analysts found that the stability of private core real estate investments offers a degree of inflation protection without increasing overall plan volatility.

Related: Now’s the time for more real estate investing in your DC plans

“Our analysis of prior drawdowns suggests that, within professionally managed solutions, an allocation to private core real estate, and a smaller allocation to real estate investment trusts (REITs), can help close the DB-DC investment opportunity gap and strengthen participants’ retirement outcomes,” the report said. “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.”

The report noted that in the post-COVID investment world, core real estate outperformed traditional asset classes over one- and three-year time periods, delivering total returns of 27.3% and 10.3%, respectively.

The analysis also places a higher emphasis on private real core real estate, with a smaller percentage of REIT investment. “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,” the study said. “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.”

Complexity may have hindered investments in the past

According to Venter, DC plans may have relied less on private core real estate than DB plans because of perceived complexity with the investments. “Early in the market evolution, DC plans were concerned with the perceived operational complexity of including private real estate,” she noted. “That concern has largely been addressed, which is demonstrated in the $79.4 billion of DC capital that is currently invested in private real estate.”

She also noted that less regulatory support and sensitivity to fees also hampered investment in this area. However, the market has evolved, making private real estate more attractive. “As we move into a post-COVID business cycle, the diminishing opportunities in traditional asset classes have made the inclusion of Core private real estate essential, not optional, in portfolios,” she said. “A small allocation can have a meaningful impact.”