Downside protection is the risk mitigation of an investment losing value. Portfolio managers can minimize losses via stop-loss orders, purchasing assets that are negatively correlated to the asset being hedged, or broad portfolio diversification, among other strategies. By proactively working to prevent loss, investors can more quickly recover their portfolios and realize higher upside over time.
What is Downside Protection in Commercial Real Estate?
As an alternative asset, real estate can serve as a strong addition to a portfolio when diversifying for downside protection. Because private real estate is highly uncorrelated to the stock market, its value is not affected by the same volatility or economic downturns. This means that a portfolio will be less affected by short-term fluctuations or losses if the stock market declines, as it continues to earn dividends on the long-term investments. As investors benefit from alternative asset allocation on a high level, they can also diversify within real estate, with each additional investment further diversifying their risk profile.
Real estate also acts as a hedge against inflation, mitigating the risk of losses associated with the decreasing purchasing power of money. Because property values tend to stay on a steady upward curve over time, and higher home prices often equal higher rent, real estate investments can provide recurring income that keeps pace with or exceeds inflation in terms of appreciation. During inflationary periods, investors may consider allocating to private real estate as a method of downside protection.
While allocation into alternative asset classes protects against downside risk, no investment is risk-free. A full downside protection strategy includes the entire portfolio. EquityMultiple follows a few steps to avoid losses for investors and build protection into investments. These include:
- Conducting exhaustive diligence on every investment we consider, ultimately selecting fewer than 10%
- Seeking to work with only experienced real estate firms
- Stress testing our underwriting assumptions
- Considering the “last dollar basis” of the investment
- Negotiating and structuring investor protections whenever possible
Essentially, our investment management team uses data to model for different scenarios, discusses at length the likelihood of a downside scenario happening, and considers what built-in protection they can negotiate for investors if one were to occur.
While investments will always carry risk, there are a multitude of ways to minimize it based on individual investment strategies. See here for more information regarding risk mitigation in EquityMultiple investments.
This document is for informational purposes only and is not an offer or solicitation to purchase or sell securities. Investing involves risks, including the potential for principal loss. There is no guarantee that the strategies and services will be successful or outperform other strategies and services. Certain assumptions may have been made in connection with the analysis presented herein, and changes to the assumptions may have a material impact on the analysis or results.
Past performance is no guarantee of future results. The investments discussed herein may be unsuitable for investors depending on their specific investment objectives and financial position. Investors should independently evaluate each investment discussed in the context of their own objectives, risk profile and circumstances.
All opinions expressed herein constitute the author’s judgement as of the date of this article and are subject to change without notice. Statements made are not facts, including statements regarding trends, market conditions and the experience or expertise of author are based on current expectations, estimates, opinions and/or beliefs. Such statements are not facts and involve known and unknown risks, uncertainties and other factors. Past events and trends do not predict or guarantee or indicate future events or results.
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