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Understanding historical returns while not a predictor of the future can be insightful when comparing property types.  Both the overall return (income plus appreciation) and the quality/stability of that return should be considered.  Average returns over the last thirty years (income and appreciation combined) are listed below for several popular property types:

Apartments: 11.9%  
Hotel: 12.7%  
Industrial: 10.4%  
Office: 9.1%  
Retail: 10.3%  
Average: 10.88%

There are numerous factors that impact performance over time.  While the average might be one number over thirty years the current return can be significantly higher or lower depending on economic circumstances.  A recent example would be the impact of an improved global economy on industrial properties (average returns in last 3 years, 15.3% while the thirty year average is 10.4%). 

Specific property characteristic can impact performance.  An example would be the high cost of tenant improvements for offices. This expense slowed the recovery from the last down turn of this asset class when compared to other property types.  The recovery was exacerbated by a long standing oversupply of office space.  In many markets this oversupply has come close to equilibrium in the last few years.

Hotels are another example of specific property characteristic impacting investment returns.  Because tenant occupancy is not secured by long term leases hotels are vulnerable to sharp swings in performance as can be seen after the 9/11 attack.  For the same reason (lack of long term leases) hotels have the distinct advantage in a rising economy of being able to quickly adjust their rents upward providing increased cash flows.  This greater ability to be sensitive to demand and economic conditions can be tempered if there is an oversupply of available rooms or the economy turns down.

Apartments have the advantage of a large tenant base that fills an on-going need.  In certain market cycles apartments can suffer from over supply which can dilute investment performance.   This oversupply is frequently caused by overbuilding but sometime is caused by other factors.  An example would be the slackened demand caused by renters becoming homeowners as a result of lenient lender underwriting prior to the 2007 sub prime meltdown.  This distorted the number of renters looking for apartments and put downward pressure on rents and occupancy rates in many markets.

Another example would be the run up in consumer confidence prior the 2007 credit crunch.  For several years prior to the crunch retail properties enjoyed an average 19.8% return versus their thirty year average of 10.3%.  Given the low historical volatility of this investment a 10.3% average return is very respectable and should be considered. Betting the farm on a continued 19.8% return would be unwise.

It is important to understand both the characteristics of an asset class and the supply/demand drivers of the location that asset is situated in.  Long term restraints on supply (example, shortage of build able land) coupled with population, job or income growth are strong indicators of a successful investment opportunity.

To properly understand which asset class best fills an investors needs it is important to understand the amount of return volatility or fluctuation a property type has.  Looking simply at the average return does not tell the entire story.  Evaluating returns is both a quantitative and qualitative process. 

For example if high cash flow is the goal, investing in an asset like hotels on the surface is appealing with its historic high average returns. The issue is qualitative; meaning what is the likelihood that the cash flow will be interrupted.  As can be seen in the aftermath of 9/11 hotel cash flows are more easily interrupted than other asset classes with long term leases.  The risk is can the investor and property adequately cope with the interrupted cash flow and is that risk worth the added return for a given investor.

Over the last thirty years apartments and retail properties have provided consistent returns while hotel and office properties proven more volatile.  Each asset class has a separate set of drivers that need to be understood and considered in order to make a wise decision as to what fills the individual investors risk/reward needs best.

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