Real Estate and Diversification
May 20, 2022
Diversification is one of the key tenets of a successful investment portfolio. Exposure to different asset classes and sectors can be beneficial, in order to reduce your risk and maximize your potential returns. Real estate can be an option to achieve this ideal diversification. The most common tactic investors use to create a balanced investment portfolio is to spread their money across three popular classes of assets: stocks, bonds, and real estate.
Each of those assets plays a different part in balancing an investment portfolio. For example, stocks are known for their potential to generate higher returns in comparison to fixed-income securities, but they are also very volatile. Bonds tend to be much less volatile than stocks, but they tend to offer lower returns. Real estate falls somewhere in the middle: it is not as volatile as stocks, but it can offer higher return potential than bonds.
Wealth preservation is a strategy that involves investing in assets that will maintain or grow in value over time. Many investors believe that real estate is one of the best asset classes for wealth preservation. Billionaire Andrew Carnegie famously said that 90% of millionaires got their wealth by investing in real estate. But probably not just any real estate. Ultra-rich people are known for owning high-quality, income-producing real estate, like downtown high rises and multifamily apartment complexes.
According to TIGER 21, high net-worth individuals invested the vast majority of their wealth into real estate at nearly a 30% allocation in 2021. Private Equity and Public Equity are trailing closely behind. There are a number of reasons why real estate is considered to be a favorable investment.
First, it is a tangible asset that you can see and touch. This makes it less volatile than stocks, which can go up or down in value very quickly. Second, real estate is in demand: people will always need somewhere to live! This means that, over time, the value of your property is likely to increase. Finally, real estate can generate income: you can earn rental income from your tenants or invest in short-term rentals.
All investments carry risk and real estate has its own unique challenges. If you're a landlord you're subject to occupancy risk - the risk that your tenants will move out and you won't be able to find new ones. You're also subject to interest rate risk - if interest rates go up, your mortgage payments will increase. And finally, you're also subject to property value risk - if the value of your property decreases, you may find it difficult to sell or refinance.
Not all real estate investments are created equal. In order to mitigate the risk of your portfolio overall and to ensure ongoing and steady growth, consider diversifying your real estate portfolio across different asset classes, asset types, geographical markets, and more. Make sure you understand the risks involved in each type of investment.
21, Tiger. “ASSET ALLOCATION REPORT 2021: 1ST QUARTER.” TIGER 21, 2 Dec. 2021, tiger21.com/insights/asset-allocation-report-2021-1st-quarter.