Real estate is an alternative asset with less volatility
As you’ve probably heard by now, the stock market is extremely volatile at the moment. In Wall Street parlance, the market is undergoing what can politely be called a “correction.” The S&P 500 has fallen by about 9% this month alone, and the Dow Jones industrial average plunged more than 1,000 points immediately after the market opened yesterday (ultimately finishing the day down nearly 600 points). Investors are concerned that China’s economic slowdown will lead to further losses in the coming months. What’s an investor to do when the market falls this rapidly?
Now, we certainly don’t advise you to go out and sell all of your equity holdings today. The stock market is inherently volatile, and selling immediately after a big loss only serves to lock in that loss. Historically, the stock market will generate positive returns for investors over the long-term, with “long-term” being defined by 10+ years. If you’re confident in your portfolio allocation, one bad month shouldn’t cause you to change course.
That being said, it’s only natural for investors to wonder if they are over-allocated in equities after a large stock market drop. After the bull market of the last 6 years, many investors have become accustomed to a constantly rising market. For newer investors in particular, this may be their first opportunity to assess their risk tolerance in a falling market. Investors who have a 90%+ asset allocation in equities are likely a little bit uneasy at the moment.
Real Estate as an Alternative Asset
If you’re an investor over-allocated in equities and looking for an alternative, we suggest that you consider real estate. Let’s be clear – real estate investing carries its own risks. No form of investing is risk-free, and generally the greater the potential returns, the greater the potential risk of loss. This is true in the stock market, in real estate, and everywhere else.
Real estate investing, though, offers features that investors who are concerned about stock market volatility might be attracted to. While there obviously can be downturns, real estate (or more precisely, the land underneath a property) is generally an appreciating asset. Even when the real estate market suffers a downturn, housing values will not plunge 5% in 5 minutes, as happened when the stock market opened yesterday. The stock market is subject to high-frequency trading, which has only exacerbated the volatility of the market (high-frequency trading accounted for nearly half of last Friday’s trading volume). These “flash” crashes and recoveries usually have nothing to do with the strength of the underlying businesses, which can be frustrating for more conservative investors. Real estate valuations are generally much more tied to the fundamentals of a property and market.
REIT Correlation with Equities
We’ve discussed this topic before, but this is another advantage that real estate crowdfunding (and other forms of direct real estate investing) has over publicly traded REITs. Large REITs such as General Growth were not immune from yesterday’s selloff. As we’ve previously mentioned, the stock performance of REITs correlated with the stock market nearly 80% of the time from 2007 to 2013, up from 47% between 1980 through 2006. REITs certainly have their positives, but it is difficult for them to act as a diversifier in one’s portfolio when 80% of their price correlates to the broader stock market.
Of course, the real estate market is not unaffected by broader market trends, and no one can predict if this stock market drop will be a blip or the start of a longer bear market. Commercial Property Executive notes that “[e]ven institutional investors have been known to up their allocations in real estate in the face of a weakened stock market,” and speculates that commercial real estate and larger residential properties will benefit while the single-family market will suffer. We won’t hazard a guess as to what the market will do. We will say, though, that if you’re finding that you’re over-allocated in the equities market, you should consider real estate as an alternative. Real estate may provide your portfolio with a buffer to allow you to weather the falling stock market, and can help you weather the storm until a bull market returns.