Source: S&P 500, Bloomberg U.S. Aggregate Bond Index, NCREIF Fund Index – Open End Diversified Core Equity
Diversification of Investment Portfolio Assets
Another one of the benefits of investing in real estate is diversification. Diversification is a cornerstone of modern portfolio theory, prompting many investors to incorporate real estate properties into their investment portfolios.
Low Correlation With Stocks and Bonds
When considering diversification, it’s crucial to examineinvestment correlation, a statistical measure of the relationship between two variables.
In this context, correlation coefficients range between +1 and -1. A coefficient of +1 denotes a perfect positive correlation, implying that the two variables move in tandem.
Conversely, a -1 coefficient signifies a perfect negative correlation, indicating opposing, mirrored movement between the variables. A correlation coefficient of zero signifies complete independence between the variables.
Investors prioritize diversification to mitigate portfolio risk and real estate ownership holds a long-standing reputation for maintaining low correlation coefficients with both stock and bond markets. This characteristic positions real estate as an ideal choice for diversifying investments.
Potential Hedge Against Economic Recession or Inflation
Real estate’s resilience extends beyond serving as an inflation hedge; it also performs admirably duringeconomic recessions.
Recessions, characterized by two consecutive quarters of GDP decline, have occurred multiple times throughout history. A review of these periods reveals that, despite economic downturns, rent growth for apartments remained positive in nine out of ten recessions over the last seventy years.
Vacancy rates have experienced only negligible increases during recessions, never exceeding more than a one percentage point gain. Apartments have historically demonstrated strong occupancy rates, maintaining stability in both prosperous and challenging economic climates.
For deeper insights into multifamily real estate’s performance during recessions, explore these informative articles:
- Safe Haven Assets to Consider During Economic Downturns
- Recession-Proof Investments
- How Multifamily Investing Can Resist a Recession
- How Would a Recession Affect Multifamily Investing
Freedom, Flexibility & Autonomy in Your Investment
Real estate investing offers a level of flexibility not commonly found in paper assets, allowing investors to choose their level of involvement.
Active or Passive Investing Models
Active investing involves assuming the role of an asset manager responsible for acquisitions, dispositions, capital improvements, and operational oversight. This approach necessitates substantial time, experience, and expertise.
Many accredited investors maintain careers outside of real estate, lacking the requisite resources to excel in active management. For these individuals, passive investing offers a more viable path. Passive investors participate alongside other investors, leveraging the expertise of professional real estate asset managers, therefore minimizing their hands-on involvement.
Exploring Real Estate Investment Options
Real estate investing offers diverse options to cater to various investment objectives, such as diversification, passive income generation, and long-term wealth creation.
Beyond choosing between active and passive investment models, investors also face choices regarding property types.
Understanding the Different Types of Real Estate Investments
Real estate can be broadly categorized into residential and commercial properties. Residential real estate encompasses single-family homes, duplexes, triplexes, and quads.
In contrast, commercial real estate serves business or investment purposes and encompasses six distinct categories:
- Multifamily
- Office
- Retail
- Industrial
- Hospitality/Hotel
- Special Purpose
Residential Property (Single and Multifamily)
Residential real estate comprises properties with one to four units, while multifamily properties include those with five or more units.
Multifamily real estateenjoys the advantage of qualifying for nonrecourse commercial lending. It provides investors with enhanced flexibility compared to traditional residential lending with its constraints, full recourse nature, and personal credit encumbrance.
Although residential real estate investors can find success within their niche, multifamily properties offer distinct advantages, including economies of scale and professional property management.
Commercial Properties
Commercial properties cater to various business and investment objectives. These property types include:
- Office: Encompassing traditional office spaces, medical offices, creative and co-working spaces, executive suites, and flex spaces.
- Retail: Spanning malls, strip malls, community centers, lifestyle centers, freestanding retail, and power centers. This category includes establishments such as drug stores and grocery stores.
- Industrial: Involving the manufacturing, processing, or storage of goods, including manufacturing centes, warehouses, cold storage facilities, truck terminals, and data centers.
- Hospitality: Primarily comprised of hotels, motels, and resorts.
- Special Purpose: An eclectic category encompassing properties like churches, self storage units, gas stations, amusem*nt parks, farms, museums, and theaters, among others.
REITs (Real Estate Investment Trusts)
Real estate investment trusts (REITs)are often likened to real estate-flavored stock because they are investments focused on the real estate sector of the stock market. It’s important to note that investing in REITs introduces more stocks to your portfolio, rather than direct real estate assets.
The distinction is vital since REITs historically exhibit higher correlations with the stock market, resulting in increased volatility. Furthermore, REITs do not offer the same tax advantages as direct real estate investments.
Are There Any Drawbacks to Investing in Real Estate?
While real estate offers a host of benefits, it’s crucial to recognize that all investments come with inherent risks, although the degree of risk varies.
As you construct your investment portfolio, it’s wise to consider the Sharpe Ratio, a measure of the risk-adjusted return that accounts for an investment’s return in relation to its risk. High Sharpe ratios indicate superior risk-adjusted returns, helping you identify assets that align with your financial goals.
It’s noteworthy that direct real estate investments have consistently demonstrated superior risk-adjusted returns for over two decades when compared to stocks and bonds. This robust risk-adjusted return is yet another compelling advantage of investing in real estate.
Initial Capital Requirements
One of the initial barriers faced by aspiring real estate investors is the capital required to initiate their ventures. Typically, residential real estate investments require a minimum of twenty percent down payment to avoid private mortgage insurance. This ensures an 80% loan-to-value ratio and the application of leverage.
Considering the current average U.S. home price of $410,200, a twenty percent down payment amounts to $82,040. For commercial properties, especially larger, multimillion-dollar assets, the capital demands are even more substantial. Historically, these capital constraints limited commercial real estate investments to affluent individuals and institutional investors.
However, fractional investing has emerged as a game-changer, enablingaccredited investorsto pool their resources and acquire significant, stable properties in the United States. These investors can participate in such opportunities with as little as $50,000 to $100,000.
Selecting the Right Locations
Real estate investment’s success is profoundly influenced by market dynamics. Investing in markets characterized by long-term population growth, ample job opportunities, and favorable landlord-tenant laws can spell the difference between success and disappointment.
A common pitfall involves focusing solely on discounted properties in proximity to one’s residence without adequately assessing the market’s overall quality. Neglecting market-centric risks can jeopardize investment returns.
At 37th Parallel Properties, we employ a meticulous approach, analyzing numerous metrics for major Metropolitan Statistical Areas (MSAs) in the U.S. We then select the top-performing markets to invest in.
Our investor base spans all fifty states and various countries, with passive limited partners benefiting from our professional services, regardless of theirgeographical proximityto the properties. Proximity to the investment location is no longer a requisite, as our investors access top-performing markets remotely.
Patience in Pursuit of Substantial Returns
When you invest in real estate, you have the potential to profit in four ways. There is the ongoing cash flow or yield you receive from operations. There are also the tax benefits that come with investing in real estate. Lastly, equity grows from paying down the mortgage and appreciation.
One of the benefits of real estate investing is the potential to make significant returns. But it might not feel that way in the beginning.
If you own the property for years, the only return you’ll typically receive is ongoing cash flow from your rental income. The equity buildup only hits your bank account once the property sells.
I’ve had calls from investors who need help understanding this. I’ve heard, “I got six percent from my real estate this year, but thestock marketreturned ten percent.”
That’s an apples-to-oranges comparison. The stock market reports a total return (dividends and equity growth), whereas real estate only reports the cash flow distribution and not the equity or property value growth.
Later, after the property sells, those same investors receive the equity growth from their investment, and their overallreturn on investmentsoars. At that point, it becomes an apples-to-apples comparison, and the benefits become clear.