Navigating Economic Uncertainty: The Wealthy’s Resilience

June 28, 2023

Do you ever wonder how economic downturns influence the investment habits of high-net-worth investors?  While fearful high-income earners may shy away from new deals, history reveals that the wealthy remain steadfast, seizing exceptional opportunities during challenging times. Data shows that the ultra wealthy use real estate investments, coupled with equity allocations and prudent risk management and have consistently yielded superior returns. Uncover the key to navigating market fluctuations and leveraging investments for long-term growth below.

So, what defines wealth? According to the financial industry, individuals with a minimum of $1 million in liquid personal assets are considered high net worth (HNW) investors. However, an even more influential group known as ultra-high net worth (UHNW) investors, as defined by asset management firm KKR, hold $30 million or more in assets. With such substantial wealth, these individuals possess the power to shape their financial destinies.

A recent report by Bank of America (BOA) revealed intriguing statistics about the composition of wealthy investors. Baby boomers comprise the majority, accounting for 62%, while Generation X stands at 20%, and millennials and the silent generation each represent 9%. Interestingly, only 1% of Gen Z is currently considered wealthy. However, this generation is poised to experience a significant surge in wealth, thanks to a historic generational transfer of wealth that will unfold until 2045.

Ron Diamond, a renowned figure in the wealth advisory field, heads an esteemed wealth advisory firm with over $250 million in assets. As the family office chair for the national HNW network named Tiger 21, he has witnessed an unprecedented transfer of wealth, which has led to a surge in capital flowing into private equity. Diamond, along with BOA, acknowledges that investment practices differ based on age and level of wealth.

Historically, HNW investors have allocated approximately 50% of their assets to stocks, 20% to bonds, 25% to alternatives, and 5% to cash, as noted by global investment firm KKR in 2021. However, Diamond points out a notable shift in recent years, with alternatives claiming a larger portion of the UHNW portfolio. For UHNW investors, the allocation typically stands at around 30% to stocks, 10% to bonds, 50% to alternatives, and 10% to cash.

The evolving investment landscape has prompted a change in asset allocation among the wealthy. Bank of America’s report highlights a generational shift characterized by a higher percentage of real estate, private equity, and other alternative investments. Young, affluent investors are three times more likely to allocate their wealth to alternative investments and half as likely to invest in stocks. This trend can be attributed to their unique circumstances, such as inheritance or success in private markets through startups, cryptocurrencies, and other ventures.

Remarkably, the allocation to real estate and other alternatives exhibits a positive correlation with an individual’s wealth. Ernst & Young’s survey reveals that 29% of HNW households and 81% of UHNW households rely on alternatives in their investment portfolios, compared to only 14% of mass affluent households. Clearly, investing in alternatives has become a favored strategy among the wealthy, enabling them to maximize growth and wealth preservation.

Real estate has long enticed wealthy investors, and it continues to claim an increasingly significant share of their portfolios.  As you know, I have long since felt that real estate isn’t really “alternative.”  Over the past decade, private equity real estate assets have achieved a 10% compounded annual growth rate, according to Bain Capital’s 2023 Global Private Equity Report. Additionally, the emerging infrastructure and construction sector, perceived as less cyclical than traditional real property, experienced 18% growth.

Ron Diamond, with his vast experience in the field, asserts that historically, real estate has proven to be the most lucrative asset class for HNW individuals. Consequently, an increasing number of family offices are venturing into these investments. Public markets are becoming more challenging to generate alpha, while the private markets, encompassing private equity, real estate, venture capital, and credit, offer more promising opportunities for superior risk adjusted returns.

While institutions exercised caution during the unsettled economic climate of 2022, decreasing their investments in real estate by 28%, wealthy private equity investors displayed a more resilient approach, reducing their investments by a mere 8% compared to the previous year’s record fundraising levels.

UHNW investors consistently allocate more of their wealth to real estate than equities. On average, they invest 32% of their wealth in residential properties, 26% in equities, and 21% in commercial properties, as highlighted by 2023 Knight Frank Wealth Report. The most common type of commercial nonresidential property was offices, with the healthcare sector accounting for 35% of these investments. Notably, environmental factors play a significant role in the investment decisions of the wealthy, with 57% of wealth advisors stating that their clients consider properties with green energy sources.

Private real estate investments offer numerous advantages that align with the investment strategies of UHNW individuals. These advantages include diversification and risk management through low-volatility, low-correlation alternatives to public equities; passive income generated from stable cash flows through rents; protection against inflation; stability during uncertain economic conditions; greater control and value-add opportunities through direct investment; and tax advantages associated with depreciation and capital gains.

You may wonder how economic downturns impact the investment habits of HNW individuals. According to Bain’s analysis, the current economic uncertainty will likely reduce the appetite for limited partners to engage in new deals after years of record allocations to private equity. However, historical data demonstrates that deals executed during downturns can generate superior returns over time. The Tech Bubble Burst of 2000 and the Global Financial Crisis of 2008 serve as prime examples. Even during these challenging periods, private real estate investments delivered an impressive, annualized return of 6.8% over three five-year investment periods, compared to a 4% return using the Treasury note strategy. Their findings indicate that investors with a time horizon of five or more years, who are willing to embrace a degree of risk, can achieve returns exceeding the risk-free rate over the long term, including during downturns and recessions. In two out of the three most recent downturns, private real estate investments generated an annualized return of 6.8%, outperforming the Treasury note strategy’s 4% return. With this knowledge, astute investors can seize opportunities for outsized returns on a risk adjusted basis.

As we gaze into the future, inflation emerges as a significant factor influencing investment decisions in 2023. Knight Frank’s HNW Pulse Survey reveals that 80% of respondents consider inflation when making investment choices, with 37% stating it has a significant impact and 43% acknowledging a moderate influence. In response to the higher inflationary environment, investors may gravitate towards commercial property due to its appreciation potential. Knight Frank predicts that “real estate and alternatives will be where wealth is grown over the coming decade,” expressing optimism particularly towards residential, industrial, and warehousing sectors.

In 2022, private U.S. investors emerged as the largest source of commercial real estate capital, investing a staggering $302 billion, which constituted over a quarter of total commercial real estate investment and 66% of private investment, as indicated in Knight Frank’s 2023 Wealth Report. Although U.S. private buyers witnessed a 3% year-on-year decline in their investments, the appeal of commercial property remains strong. Knight Frank’s Wealth Report reveals that 19% of global UHNW investors plan to make direct investments in commercial real estate in 2023, while 13% seek indirect investment through vehicles like private REITs or funds. Nearly half of these investors consider real estate an opportunity for wealth creation as they seek diversification and capital appreciation as their primary objectives.

Industry experts, including David Bailin, the Chief Investment Officer of Citi Global Wealth Management Investments, concur that real estate and alternatives will be the domains for wealth creation over the coming decade. Citi expresses optimism towards residential, industrial, and warehousing sectors, citing their strong fundamentals.

Are you ready to unlock the door to wealth creation?  Are you ready to employ the investment strategies of the UHNW and seize opportunities even during economic downturns?  If so, we invite you to connect with our community and learn how.