A diversified portfolio will provide you with a steady, long-term path to growing wealth while optimally balancing risks and rewards. That’s why experts always encourage investors to spread their money across multiple asset classes.
But what does a healthy portfolio really look like? What does it include?
Diversification involves more than just spreading your investments across stocks, mutual funds, bonds, and CDs. Many people tend to overlook the value in real estate investment, which adds to your portfolio in 4 key ways: it provides two pathways to returns, offers reduced volatility, helps counteract inflation, and can add value to a community.
Benefit #1: Two Pathways to Returns
There are two ways that real estate delivers returns: cash flow and appreciation.
A property’s cash flow is the amount of collected rent that is left over once you subtract out the expenses. If you’re able to rent out a property for more than your taxes, utilities, maintenance, and any property management fees or other costs, you’ll end up with cash in your pocket – that’s cash flow.
Unlike investing in a startup, small private company, or large public corporation and waiting to cash out based on it going public or increasing its stock price, real estate can start generating income as soon as it’s rented out!
Appreciation is the amount that a property’s value increases over time. This takes into account both a higher sale price and/or increased rental values.
Even if a property has a breakeven or negative cash flow today, you could be building up equity in your property (the difference between how much it was purchased for and how much it could sell for now) while tenants cover the entirety or majority of your costs.
Real estate appreciation varies from property to property but can reach as high as 10% per year in a hot market.
Appreciation offers investors flexibility and control because it can be influenced by building improvements. In the stock market, the rise and fall of your stock price is out of your hands. But if the real estate market stalls or suffers a dip, an investor can raise a property’s value by upgrading its condition or features.
Lastly, a bonus feature of real estate investing is that it doesn’t require dollar-for-dollar capital to buy. If you want to invest $500,000 in the stock market, it will cost you exactly $500,000. But with real estate, you can just make a $100,000 down payment on a $500,000 property (20%) and still benefit from the long-term appreciation on the entire $500,000 amount.
Benefit #2: Reduced Volatility
Stock prices are largely speculative. They are driven by the media, politics, and the public words and actions of company officials, among other things. These factors can completely change overnight on a mere whim.
Real estate prices, on the other hand, are more strongly influenced by a different set of forces – like the strength of a local community and demand for rentals. These tend to be slower-moving forces that take place over months or years. With real estate, your assets won’t necessarily take a nosedive just because the stock market suddenly crashes or fluctuates based on political tension. Tenants will continue to need space and pay their rent.
Our Deep Dive Into 100 Years of Historical Investment Trends white paper pointed out that, “In a strict ‘up vs. down’ comparison, between the years 1934 and 2013, commercial real estate investors enjoyed 75 ‘ups’ and only 5 ‘downs,’ while stocks and bonds both posted 60 ‘ups’ and 20 ‘downs.’”
In short, diversifying your portfolio with real estate may help you enjoy steady gains while reducing the stress caused by market swings.
Benefit #3: Counteracting Inflation
Inflation is an increase in prices over time, or equivalently a fall in the purchasing power of your dollar. It’s the reason you could purchase a car for around ~$3,000 in the 1960s but have to pay ~$25,000 for the same thing today.
Inflation chips away at the profits you earn from bonds or CDs, which are locked in at fixed rates over time. In those cases, inflation works against you. The advantage of investing in real estate is that properties are somewhat insulated from inflation. If purchase prices rise, typically rental rates and property values go up with them.
The exact amount that a property is shielded from inflation will vary based on the makeup of the building, shifts in the real estate market, and other factors.
Benefit #4: Add Value to a Community
Purchasing a stock or bond can help a company or perhaps a government institution achieve its goals, but by purchasing real estate, you have an opportunity to help transform a community.
If you purchase a property in a middle-tier neighborhood and decide to fix it up, local contractors, plumbers, painters, etc. gain employment. Locals get clean, up-to-date spaces to live in. Other businesses gradually start to see the community as an attractive place to take root. Suddenly, you’ve helped to build up the community, while also building up the value of your investment.
There are very few other investment classes where you can have such a direct, hands-on impact on the outcome of your investment.
Like any investment, real estate investing poses risks. You’ll need to choose your property wisely to be set up for success. But these are 4 key reasons why you should consider real estate investment crucial to a balanced portfolio.
At Birchstone Investments, we provide top-notch analysis of real estate and offer investment opportunities for new and experienced investors. If you would like to learn more about the advantages of diversifying your portfolio with real estate or information on our offerings, get in touch with our team.