Before delving further into the mechanics of real estate valuation and investment theory, let’s address a fundamental question: why invest in real estate? If you’re here, you probably already have a decent handle on why people hold real estate in their portfolios. Let’s take a quick look at the main reasons private commercial real estate is being viewed more and more as an indispensable asset class by savvy investors.

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 a key element of 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 near or above 20% of the overall portfolio to real estate, while individuals average less than 3% of portfolio allocation toward real estate.[1]

The Yale Endowment

Yale Portfolio asset breakdown

This partially reflects greater appetite for illiquid holdings among institutional investors like Yale, but there are several other reasons direct real estate ownership is consistently favored by large, experienced investors:

  • 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 other asset classes. Real estate remains such as 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) – blind composite trusts of real estate holdings, long available to investors – 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 RIA. (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.

    Real estate returns vs. other asset classes

    Historical average annual returns by asset class.

EQUITYMULTIPLE enables you as an individual investor to realize these same benefits, and allocate a more meaningful portion of your portfolio toward real estate. Relatively low minimums help you not only access commercial real estate, but also diversify across real estate sub-asset classes (types of properties), markets, and risk/return profiles.

 

[1] https://www.bloomberg.com/news/articles/2015-10-06/yale-endowment-model-thrives-as-swensen-proteges-post-top-gains

 

By EQUITYMULTIPLE Staff
EquityMultiple's team features real estate industry veterans, technology-driven analysts, and dedicated armchair economists.
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