Real estate provides investors with powerful diversification benefits.
Portfolio diversification is one of the most powerful ways for investors to reduce their risk. The idea is straightforward: one asset class may increase in value to offset losses in other classes. True diversification requires investments in a large range of assets, both in type and in geographic distribution. While many investors focus on stocks and bonds, alternative investments, including those in real estate, can provide significant diversification, steady income and capital gains.
Why Real Estate?
Many investors were scared away from real estate during the economic crisis of 2007-08, when just about every type of investment lost value. However, that crisis was a historic anomaly. For example, home prices increased by 12 percent in the 12 months beginning in April 2012. While this is unusually high on a historic basis, it makes the point that real estate is a valuable asset class that broadens and diversifies your portfolio.
It’s important to understand that real estate need not provide the best return among all asset classes — its primary value is that real estate returns are often inversely correlated to those of other assets, which reduces portfolio volatility. As index fund proponent Rick Ferri wrote in All About Asset Allocation:
Real estate is one of the few asset classes that has low correlation with bonds and varying correlation with stocks . . . a well diversified portfolio that holds real estate investments alongside stock and bond investments has proved to be a more efficient portfolio than one that does not include real estate investing.
Misconceptions About Real Estate Investing
Investors frequently shy away from real estate because they are only familiar with the “do-it-yourself” approach – buying a small property, improving it and either renting it out for income or selling it for a gain. While this is still the model for many income seekers and property “flippers,” it is by no means the only one. In truth, investing in real estate has never been easier – passive investments are available that require absolutely no involvement by the investor in managing the property. Historically, this type of passive opportunity was only available in a few ways:
- Real estate mutual funds and investment trusts are widely available and provide passive investment opportunities, but investors have little say in how the fund manager chooses to invest. Investors can sometimes select funds specializing in certain geographic locations or types of property, but the sponsor will not be soliciting investment ideas.
- Large private syndicates are just that: private. It takes a lot of money to enter these private investment clubs, and investors have to know the right people.
- Real estate hedge funds offer professional management and sophisticated trading techniques, but once again, participation is limited to the well-connected.
Thankfully, a new type of real estate investing has become available for regular investors who want to select, but not manage, property development and rental projects. It’s called real estate crowdfunding.
The Evolution of Real Estate Investing
Real estate crowdfunding is an investment technique in which investors buy shares of equity or lend money to real estate sponsors. Platforms like PeerRealty provide a crowdfunding investment website, known as a portal, that helps bring together real estate investors and sponsors. SEC regulations currently require that investors be accredited to be eligible for this kind of investment. Accredited individual investors must have at least $1M in assets, not counting their primary residences, or have earned at least $200,000 in each of the two previous calendar years.
In 2015, the SEC introduced new rules that will allow non-accredited investors to enter into certain types of equity crowdfunding and potentially real estate crowdfunding deals. Unlike mutual funds and REITs, crowdfunding allows real estate investors to pick and choose specific investments without getting involved in the management of those properties. Investors can select properties by type and community, receive equity from the sponsor and participate in the income and/or gains earned on the property. By investing in several different properties, investors can add substantial diversification to their portfolios, which over the long term should decrease overall risk.