Diversifying your investment portfolio is always a good idea, even when you’re looking at “unconventional” investment vehicles like real estate. Real estate investments represent a fringe approach to investing because they are not nearly as liquid as other investment options like stocks, bonds, cryptocurrencies, etc.
You can’t buy and sell properties the way you can open and close positions through your trading app. The lack of liquidity and the historically strong performance of real estate turn it into a good hedge against the volatility of other investments such as cryptocurrencies and stocks.
Using Real Estate to Diversify Your Portfolio
Real estate falls outside of what investors would define as traditional investment vehicles. According to common wisdom, traditional portfolios feature a 60 percent allocation to blue-chip stocks and 40 percent to bonds. The logic is simple. Since the correlation between the two asset classes is low, this distribution creates enough diversification to protect investments from volatility.
Real estate does not correlate with either of those asset classes, offering a great counterbalance to risky investments in tech stocks and cryptocurrencies.
Investors interested in real estate for diversification purposes should turn their attention to private market real estate only. Publicly traded real estate makes a poor diversification vehicle since it correlates with other public assets.
How to Invest in Real Estate?
The simplest way to invest in real estate is to do it yourself. Find a property you like. Buy it.
You can also invest in real estate through real estate investment trusts (REITs), equity funds, and online real estate platforms.
These options represent viable real estate investments, but private market real estate is the best hedge as it doesn’t correlate well with public assets due to its inherent inefficiencies.
These inefficiencies allow well-supported companies to generate market-beating returns in this market segment.
Retail investors should be aware, however, that only accredited investors have access to most of the private market opportunities.
It is also possible and recommended to diversify your investments within the real estate sector. Such additional diversification can eliminate geographic and property sector overexposure.
Private Market Real Estate
Are private market real estate investments right for you? Long considered the privilege of institutional investors, private market real estate has become more and more popular over the last few years. The outstanding returns draw untold amounts of money into this market segment every year.
Investment portfolios that include private market real estate perform better than traditional 60/40 stocks/bonds portfolios.
According to investopedia, over 20 years, private market real estate investments yield average returns of over six percent while stock-based portfolios’ rates average less than two percent.
In addition to the attractive returns, private market real estate investments act as passive income sources.
Be aware that owning your house does not count as a private market real estate investment that will lend your portfolio some much-needed stability. Owning rental properties is different, however.
Hedging Against Inflation
Inflation has always been a menace for investments. Real estate is immune to its effects, however. The price of real estate tends to rise together with inflation. Sometimes, the rise of real estate prices can outpace inflation.
Why do real estate investments act as an effective hedge against inflation?
Hard assets like real estate have an intrinsic value and utility beyond their current monetary value.
Rental prices tend to go up together with the rise of property prices. That inflation-proofs the passive income aspect of the investment as well.
Nowadays, inflation is a bigger problem for investors than it used to be a few years ago. With an ongoing global pandemic, wars, and economic sanctions taking hold world-over, the value of fiat money has embarked on a precipitous nosedive.
Real Estate Prices as a True Measure of Inflation
We measure inflation through the CPI (consumer price index). Like a stock index, the consumer price index consists of a selection of consumer goods, the prices of which vary over time. The CPI tracks the price changes.
Although it includes energy prices, the CPI does not include real estate.
Real estate is not something we consume. It retains its value longer than consumer goods, including cars and household appliances. Yet if you want to learn exactly how much less your money can buy today, comparing real estate prices from a year ago with today’s prices is a simple exercise. And this exercise will probably yield a much more alarming number than the CPI.
Real estate gives investors a tool to defeat inflation, achieve portfolio stability, diversify, and earn a passive income. It can generate returns well above the market average. It represents a sensible addition to any well-performing and stable portfolio.