Why Invest in Real Estate?
Before exploring the mechanics of real estate valuation and investment theory any further, let’s address a fundamental question: why invest in real estate? While you may be aware that some individuals hold real estate in their portfolios, it is still worth examining the main reasons private commercial real estate is viewed as an indispensable asset class by savvy investors.
Key Takeaways:
- Private commercial real estate provides a compelling set of benefits unrivaled by other asset classes.
- These benefits may be magnified during periods of economic volatility, as we expect in the wake of the COVID-19.
- Institutional investors like the Yale and Harvard Endowments have historically allocated 20% or more to private real estate for these reasons.
Why Invest in Real Estate? Diversification Is Key
The most important reason to include real estate as a significant portion of your overall portfolio is the diversification benefits it can bring. Modern portfolio theory holds that diversification is key to reducing portfolio risk and optimizing returns.
High-net-worth individuals and institutional investors have long held substantially higher allocations of real estate ownership in their portfolios than individual investors. The Yale Endowment, headed by heralded chief investor David Swensen, has famously allocated significant portions of the overall portfolio to real estate. While Swensen has directed between 10-30% of capital into CRE, individual investors average less than 3% of portfolio allocation toward real estate.[1]
The Yale Endowment Asset Allocation (2014)
Why Else Should You Invest In Real Estate? The Reasons Are Manifold:
- Consistent Cash Flow: Many real estate investments provide regular cash flow in the form of rental income, as opposed to bonds and many stocks, which either do not generate cash-flow or do so at lower rates.
- Tangibility & Intrinsic Value: Real estate holds inherent worth and is scarce by definition. Since populations and cities grow, while the supply of developable land remains fixed, real estate has consistently appreciated in value over time.
- Downside Protection: Economic downturns negatively impact the stock market and tend to adversely affect most asset classes. Real estate remains such an essential resource in day-to-day life that losses in value are rarely of the magnitude seen in the stock market during downturns. This is particularly true in multifamily – no matter what, people will need a place to live.
- Low Correlation with Public Markets: While public REITs (Real Estate Investment Trusts) are traded—and tend to correlate strongly with stock market movements—private real estate investments show a low correlation to public debt and equity markets, thus providing strong diversification benefits in portfolios that already contain stocks and bonds.
- Tax Benefits: Depreciation of the underlying asset can shelter rental income from tax. There are various other potential benefits with respect to taxes, including the ability to invest via a self-directed IRA. (NOTE: EquityMultiple does not provide tax advice, please consult your tax advisor).
- Strong Historical Returns: While income-producing stocks and other assets have sporadically outperformed real estate in individual years, real estate has shown a higher average return while exhibiting less volatility.
- A Potential Hedge Against Inflation: Aggregate price increases across the economy lower the bottom-line net returns of investments. CRE assets potentially provide a hedge against the erosive effects of inflation because real estate is scarce; rents can be increased programmatically to account for inflation; and prices are incorporated into asset pricing in the form of input costs (building materials and labor). For more, please review this article.
These factors have been put into focus by the economic realities of COVID-19, and the expected volatility of the post-pandemic environment. With many economists expecting a period of greater inflation, public market volatility, and persistently low interest rates (and hence limit opportunities for current yield), private real estate may provide even greater appeal.
Of course historical returns are the most compelling reason to invest in any class. The historical performance of private, commercial real estate over the past few decades stands as another powerful reason to invest in the asset class.
Average Returns
EquityMultiple enables individual investors to realize these same benefits and allocate a more meaningful portion of their portfolio toward real estate. Relatively low minimums not only provide access to commercial real estate, but also allow for diversification across real estate sub-asset classes (types of properties), markets, and risk/return profiles.
– Andrew Carnegie
The Bottom Line
Private, commercial real estate has been a preferred asset class of institutional investors, like the Yale Endowment, for decades. Benefits of the asset class are both tangible and supported by historical performance data. Investing in private real estate is a logical next step for any self-directed investor who is already allocated to stocks and bonds and looking for diversification and a long-term asset allocation strategy.
However, real estate is not a monolithic asset class. Different strategies, capital types, property types, and geographic concentrations can all contribute to varied risk/return profiles and opportunities for further diversification. We will explore these concepts in depth throughout this series.
[1] https://www.bloomberg.com/news/articles/2015-10-06/yale-endowment-model-thrives-as-swensen-proteges-post-top-gains
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