PREMIER Business & Finance: In the fairly recent past our homes were one of our primary methods of growing our net worth. After the real estate bubble burst, real estate became more a function of simply housing. The economy is changing and homes are again becoming more instrumental in financial growth.
PREMIER Business and Finance
We all know that real estate serves primarily as a means to house ourselves and our families. In many ways real estate is really a consumable commodity. In the fairly recent past our homes were one of our primary methods of growing our net worth. After the real estate bubble burst, real estate became more a function of simply housing. The economy is changing and homes are again becoming more instrumental in financial growth.
There are complexities in looking at real estate as a portion of our overall portfolio.
I asked Mark Boucher, Branch Manager/Registered Principal with Raymond James Financial, his opinions. Mark is a recipient of the 2015 Five Star Wealth Manager Award*.
Can Real Estate Stabilize Your Portfolio? Historically used as a more tactical investment, real estate has been used as part of a long-term core strategy due to increased market efficiency and concerns about the future long-term variability of stock and bond returns. In fact, real estate is often viewed as a portfolio diversifier and inflation hedge.
If investors plan to make permanent real estate allocations in their investment portfolios, what return expectations should they have and what risks will they encounter? An investor considering the use of real estate as part of a long-term investment strategy should understand how to form return expectations and evaluate these investments in relation to more conventional investment options
Diversification: Investor’s interest in real estate has been for diversification and its ability to maintain the purchasing power of capital. The National Council of Real Estate Investment Fiduciaries (NCREIF) states that market indices for the real estate industry have shown low correlation with the returns of both stock and bond investments. This suggests that real estate investments can increase portfolio diversification.
Hedging Inflation: The inflation hedging capacity of a real estate investment comes, in part from the owner’s ability to increase rental rates during periods of inflation. Unlike manufacturing concerns and service providers, owners do not have to contend with demand elasticity in order to increase prices, but they do compete with rival properties in the marketplace; in theory, this should also raise rental rates in inflationary periods. Real estate tends to maintain the purchasing power of capital by passing on a portion of the inflationary pressure onto tenants.
Risk Management: Real estate may also reduce risk in the way properties are leased. Portfolios that have followed a cash flow strategy and decided to lock in rates in long-term leases have less exposure to market movements, but they also have less inflation-hedging ability. Certain properties that are well-occupied and contain long-term leases will have very stable income streams like annuity or low risk bond investments. Oftentimes, property returns are very stable, growing by small incremental amounts until they “pop” with some market adjustment. This change in value can be a significant portion of total return, which means that real estate investor must try to identify when those changes in value will occur. Real estate has shown itself to be very cyclical.
Portfolio Construction: It seems that the historic performance of real estate, combined with its potential to increase diversification and hedge inflation, makes the case for the inclusion of real estate in a diversified portfolio. However, those investing in real estate should remember to include the value of their primary residence in their overall real estate portfolio, because home ownership may overweight their exposure to real estate and lead to increased market risk.
The continued increase in market efficiency, as demonstrated by the continual offerings of new real estate investment products and global opportunities, provides greater motive for including real estate in one’s overall capital allocation. In addition to the potential risk/return of traditional real estate, the emergence of investments, such as real estate derivatives and 1031 tax-deferred exchanges helps investors in tax-efficiency.
The Bottom Line: Investors who have not previously considered real estate should research the myriad of real estate opportunities and work with their financial advisor to build a diversified portfolio.
Thank you Mark, for your contribution!
Please remember that your REALTOR® is not qualified to give legal or tax advice. If you have questions, please contact your appropriate professional advisor.
Branch Manager, Rancho Santa Fe, Fairbanks Ranch, Del Rayo