We’ve talked previously about how real estate investments are structured, and why savvy investors include commercial real estate in their portfolio. This article takes a closer look at real estate vs stocks and other asset classes, and the relative benefits and drawbacks.
Recap: Why Invest in Real Estate:
Here are the basic reasons investors are drawn to real estate, as compared with other asset classes. For more detail, refer back to our article on the core benefits of commercial real estate investing.
- Consistent cash flow
- Tangibility & Intrinsic Value
- Downside protection
- Low Correlation with Public Markets
- Tax Benefits
- Strong Historical Returns
Let’s now take a closer look at real estate vs. other major asset classes. To be clear, we would not suggest divesting of other asset classes entirely in favor of commercial real estate holdings. As the aforementioned article notes, institutional investors often allocate 20-30% of their portfolios to real estate.
Real Estate vs Stocks
Historically, real estate has performed comparably in aggregate to stock market indices; either may show a greater retrospective growth rate depending on which year the comparison begins. For virtually any historical period, however, the stock market exhibits greater volatility than real estate, meaning that annual returns vary to a greater degree from average annual returns. Since any rational, risk-averse investor will seek to mitigate variance from mean performance, the relative stability of real estate is a plus.
The major advantage of stocks vs. real estate investing is liquidity – whereas a real estate investment requires tying up capital (potentially for years), an investor can sell a stock position and recoup capital virtually instantaneously.
Real Estate vs Bonds and Other Fixed-Rate Vehicles
While the stock market and real estate investing offer the potential for high yield, bonds and other fixed-rate vehicles offer lower-risk, lower-return investments for preserving wealth and guarding against inflation. Indeed, most institutional investors allocate between 10 and 20% of their portfolios to bonds and other fixed-rate vehicles. Robadvisors and 401Ks will often recommend a similar range, depending on the investor’s proximity to retirement or withdrawal.
From CDs to treasury bonds to unit investment trusts to utility stocks to fixed annuities, these options offer low risk and require very little knowledge or upkeep, but limited annual returns of between .5% and 5%. With the advent of direct real estate platforms like EQUITYMULTIPLE, commercial real estate debt has emerged as a higher-yield alternative. Like these other vehicles, investing in commercial real estate debt offers stable, fixed returns, but with a significantly higher range of returns – between 7% and 11% APR. High yield commercial real estate loans like this are typically short in duration (6-18 months) and offered by private lenders instead of banks. (For more on how rates on such loans are determined, see this article).
However, fixed-rate real estate debt investments secured by the underlying property still come with attendant risk, namely the potential for the borrower to default. Government bonds, while offering lower rates of return, are often referred to as “risk-free” because of the extremely low potential for the government to default.
“Real Estate Crowdfunding” vs. Equity Crowdfunding
The JOBS Act opened the door for individuals to access private commercial real estate investments. It also created the opening for early-stage startups (from tech to ecommerce to biotech restaurants and breweries) to raise capital, and hence new opportunity for individuals in “equity crowdfunding”. Platforms like SeedInvest, MicroVentures and EquityNet now allow individual investors to operate as small-scale venture capitalists, buying shares of promising growth-stage companies.
As you might imagine, this form of investing carries great potential for return, but enormous risk: while some startups strike gold, the majority do not, and these investments have a far greater potential for 100% loss of principal than do real estate, stocks, or other asset classes. Established venture capital firms wield enormous stores of capital, expertise, and analytic acumen, and still expect to lose on the majority of investments they make. As such, individuals should approach this new investing channel very carefully. Even proponents of the young industry seem to agree
As with any real estate investing platform, investors should look carefully at the vetting measures of any startup equity crowdfunding platform they consider investing with.
Passive real estate investments behave differently from REITs, and direct ownership of property. When real estate is talked about in the context of other asset classes, people are often referring to REITs (real estate investment trusts) or direct ownership of property. While both of these investment vehicles may be viable alternatives to stocks and bonds, it’s important to keep in mind that passive real estate investing (via a platform like EQUITYMULTIPLE) brings a different set of benefits as compared to REITs or direct ownership.
Unlike publicly-traded REITs, passive online real estate investments are not subject to market swings and do not correlate heavily to public markets. In other words, for an investor already exposed to stocks, passive real estate investments in distinct properties provides superior diversification benefit and downside protection than publicly-traded REITs. Meanwhile, private, non-traded REITs typically carry high management fees (often 10% and up, as opposed to the 1-3% annual fees usually associated with online platforms like EQUITYMULTIPLE).
Direct ownership of real estate has the potential for high yield, but comes with a host of potential headaches and drains on time and capital. Like any business venture, real estate investment and management benefits from experience and scale, and individuals looking to allocate into real estate for the first time may not have the requisite experience to buy, manage, and sell commercial real estate to a favorable ROI. Furthermore, committing large amounts of capital to the purchase, management, and improvement of one or two properties may preclude the diversification that online platforms allow for; through EQUITYMULTIPLE and (a small group of) other platforms, individuals can co-invest alongside experienced real estate companies in small increments, and spread their portfolio’s real estate allocation across markets, property types, and investing strategies.
Real estate, as a tangible asset, provides a natural hedge against economic shocks, and exhibits less volatility than many other asset classes. Of course, real estate vs stocks or any other asset is never a binary decision – a strong portfolio will exhibit diversification across asset classes, and within asset classes. We will speak more to this in a subsequent article on modern portfolio theory.