Optimizing Assets: Why Add Real Estate to Your Managed Investment Portfolio
I understand that investment choices are wide-ranging and as fiduciaries, it's our responsibility to protect our client's money and/or property while also guiding them in a way to help facilitate growth according with their goals and long term plans. Real estate should stand out as a crucial asset class to be considered in any diversified investment strategy, yet it remains underutilized by many retail investors. This article explains why financial advisors should consider recommending real estate as a part of their clients’ investment portfolios focusing on its role in risk management strategies, its correlation with economic indicators, and its historical performance across different economic cycles.
Stability of Real Estate Investments
Real estate is known for its stability compared to more volatile markets like stocks or bonds. Historically, U.S. housing has appreciated at an average rate of ~4.7% per year over the last 63+ years. This consistent growth makes real estate a reliable option during economic ups and downs, where the value of physical assets tends to be steadier than that of intangible assets.
Comprehensive Risk Management and Benefits of Diversification
Incorporating real estate into an investment portfolio not only diversifies holdings but also introduces sophisticated risk management strategies. Geographic diversification, for example, allows investors to spread their exposure across various markets, mitigating risks associated with local economic downturns. By spreading investments across various asset classes, investors can lessen the impact of poor performance in any single area on their overall portfolio. Real estate provides a physical asset that often behaves differently than the stock market, offering a cushion when other investments might be falling.
Economic Indicators and Inflation Protection
The performance of real estate investments often mirrors broader economic trends. During periods of economic growth, increased business activities boost the demand for office and retail spaces, while strong job markets elevate the demand for residential housing. Conversely, during economic recessions, real estate values may stabilize, offering a buffer against the sharp declines seen in equities.
Real estate is also seen as a strong guard against inflation. Generally, as inflation increases, so does the value of real estate and the rental income that properties can generate. This relationship means that real estate investments can preserve the purchasing power of money in ways that fixed-income investments like bonds cannot, since returns on real estate are likely to keep pace with inflation.
Tax Advantages
There are several tax benefits linked with real estate that can boost the profitability of this asset class. These include deductions for mortgage interest, property taxes, operating expenses, and depreciation. These tax breaks can significantly reduce the taxable income from real estate investments, improving overall returns.
Using Leverage
Real estate is unique in how commonly leverage, using borrowed capital to increase the potential return on investment, is used. While this increases exposure to risk, the tangible nature of real estate often facilitates easier access to financing compared to other asset classes.
Steady Cash Flow
Investments in real estate can produce a regular cash flow through rental income. This is particularly attractive for retirees or other investors who need a steady income. Unlike dividends, which can be reduced or suspended, rental income is generally reliable and may increase with inflation.
Real Estate Investment Trusts (REITs)
For those advising clients who prefer not to directly manage properties, Real Estate Investment Trusts (REITs) offer a way to invest in real estate by purchasing a publicly traded product. REITs allow investors to gain exposure to real estate markets without needing to buy, manage, or finance properties themselves. They also provide liquidity, as shares can be traded on the stock market, which is not as simple with physical real estate.
Challenges to Consider
Despite its advantages, real estate investment isn't without its challenges. These include the lack of liquidity compared to other investments, the costs associated with purchasing, maintaining, and selling real estate, and market-specific risks that can affect property values. Also, real estate markets can vary greatly by location, and successful investing often requires knowledge of local conditions.
Overall, real estate is a vital part of a well-rounded investment portfolio, providing diversification, stable returns, protection against inflation, and tax benefits. For clients, including real estate in their portfolio can offer both growth and stability, improving long-term investment results.
Marc Cashin is the Founder and CEO of FORWARD at Corcoran McEnearney, representing buyers and sellers in Washington DC, Maryland, and Northern Virginia. This article was first published on LinkedIn.
