Why Invest in Real Estate?
Investing in real estate has been around for centuries and is considered one of the most-used investment vehicles even in this digitized era. For starters, investing in real estate might sound all fashioned or even a boring way to invest his hard-earned money, but historical performance figures and investment characteristics reveal why investing in real estate should be considered an integral part of any investor’s portfolio. Undoubtedly, there have been times during which investments in real estate led to catastrophic results for investors, but such is the nature of investments regardless of the asset class.
Real estate is a best in class investment choice
When assessing the attractiveness of an investment opportunity, one of the primary focus areas is historical performance. Considering the extensive time horizon in which real estate investments have existed on this planet, one would easily be able to compare the returns of real estate investments with other major asset classes.
Not surprisingly, real estate investments have provided the best return among other asset classes in developed markets. One reason why developed markets are taken into consideration is that emerging market asset class performance figures do not extend to an extensive history in the same manner in which developed market asset class performances do. On the other hand, emerging market performance tend to have a significant number of outliers that make it difficult to compare cross-asset class returns.
Warren Buffett, arguably the most successful investor of all time, advice not to put all eggs in one basket. The underlying investment theory is diversification benefits. While systematic risk, or the risk inherent in investing in any asset class which is commonly known as the market risk, cannot be diversified away no matter what, any investor would be able to negate the impact of unsystematic risk by investing in a diversified portfolio. A properly diversified portfolio would include not only stocks from various industries but also several asset classes.
The idea behind diversifying a portfolio is to invest in non-correlated asset classes and individual securities so that the risk of the total portfolio value being wiped-off due to a single credit or market event is minimal.
Considering the unique characteristics associated with real estate investments, it should come as no surprise that real estate investments are considered as one of the few asset classes that have a low correlation with stock market returns. In a study conducted by Dr. Jeffery Fisher of John Hopkins University, it was revealed that real estate investment returns still have a low correlation with stock markets around the globe, which is proof that investing in real estate investments provide a necessary edge for investors to achieve better returns from their investments.
The below graph plots the investment returns of these two asset classes and it is apparent that the correlation has been low even though both these asset classes have a positive correlation.
Ray Dalio, one of the most successful money managers of the modern era, has confirmed on many occasions why he believes investing in real estate assets should be considered a priority by many investors to achieve a sufficient level of diversification in their investment portfolios.
Real estate as an Inflation hedge
No matter where an investor resides, inflation should be one of the primary considerations when making an investment. It is an absolute necessity to invest in asset classes and securities that provide high inflation-adjusted returns. While there are some stocks and bonds that provide a hedge against inflation, there is arguably no other asset class that provides a hedge against inflation than real estate investments.
As price indexes rise, so would the value of real estate properties in a country. As prices of goods and services rise sharply possibly due to higher economic growth and activities, real estate investments will provide even higher returns, which would more than net-off the negative impact of rising inflation.
The inflation hedge provided by real estate investments is something no investor can afford to miss, making real estate an essential part of an investor’s portfolio.
Investing in real estate is not as hard as one might assume
The consensus understanding among retail investors is that investing in real estate assets is a tedious task that involves a significant number of bureaucracies. On the other hand, investing in real estate is often associated with a significant lump sum investment, which has led to the belief among retail investors that this asset class welcomes only institutional and other professional level investors. Both notions are inaccurate, but many investors tend to shy away from real estate investments because of these 2 notions even after correctly identifying what real estate investments bring to the table.
Investing directly in real estate properties require a significant capital outlay and can be considered a very long-term investment. There are tax constraints of investing in real estate properties as well, which needs to be taken into consideration. However, there are various methods to invest in real estate indirectly.
Real Estate Investment Trusts (REITs) trade on stock markets worldwide and provides an easy exposure to this attractive asset class. Moreover, a REIT usually distributes close to 90% of their net income as dividends to shareholders to obtain tax advantages, which should provide a steady and stable income stream to income-oriented investors. In fact, in the U.S., REITs account for the majority of high-yield stocks. Investing in a REIT requires a very small amount of capital which should enable any investor to have exposure to real estate properties through their brokerage accounts.
In addition, there are many mutual funds that explicitly invest in real estate related securities. These mutual funds are an effective way of exposing one’s portfolio to real estate investments.
In conclusion, investing in real estate provides various benefits including the potential for higher returns, diversification benefits, steady income, and protection against inflation. In addition to these, other benefits not discussed in this article include tax benefits, and the potential to secure long-term non-financial benefits such as being the owner of prime property. All in all, retail and institutional investors alike should invest in real estate to gain exposure to these benefits, which have proven a decisive force in achieving better investment results.