Advantages of Real Estate in Creating a Well-Balanced Portfolio
Investing in real estate can be a scary and uncertain process for many people. There are so many considerations to evaluate and many questions that need to be understood and answered. Although those issues may appear daunting, there are significant advantages in adding real estate to one’s investment strategy that should not be overlooked.
The Benefits of Real Estate Investments
Real estate investments offer many benefits that stocks or bonds do not provide. Individuals who seek not only a secure and well-balanced portfolio, but also regular cash distributions and price appreciation, realize that real estate is the avenue to achieve these goals. Logging on to check your stock and bond portfolio can be fun, but it can also be somewhat abstract. There is something appealing to having a tangible investment — something that one can see, visit, and touch. Adding real estate to an investment portfolio also brings one closer to being more self-reliant and self-assured.
Among the advantages that real estate investing can provide to a knowledgeable investor are:
- Less volatility
- Cash flow plus appreciation
- Diversified portfolio
- Historically good performance
- Limited supply
- Tax advantages
- Stocks Versus Real Estate
Investing in good stocks can produce a nice return for those with higher risk tolerance. However, stock prices can also move down and occasionally can go to $0. There are many notable examples of major corporations whose stocks have failed — Enron and MCI/WorldCom are two examples. In contrast to stocks, real estate investments can provide more security. Real estate values have never been reduced to $0. The land itself will always retain some value. Even when an old structure sits on it and will need to be demolished, the land retains inherent use and value. As a result, there is an enhanced level of security with real estate investments over stock alternatives.
We have all witnessed days when the Dow Jones Industrial Average increased or decreased by more than 1,000 points. This volatility can be very unsettling to many investors. When stocks fluctuate in this manner, some investors wonder what is the real value of a company if its price can change so dramatically in a short time? real estate prices are much more stable and generally not subject to drastic price adjustments. Its more stable pricing nature and long-term value are two primary reasons people choose to invest in it.
There are typically two investment approaches associated with stocks — growth and value. Growth stocks, which generally include most of the tech sector, are primarily focused on price appreciation and less so on paying dividends. Their investors prefer these companies to reinvest their profits into research and development in order to grow, as opposed to using it to pay shareholders a dividend.
Value-oriented stocks, such as the consumer staples and energy sectors, are focused on paying investors regular dividends. This means there is less cash flow available to reinvest into research and development or future acquisitions; but these companies provide steady cash dividends which have appeal to certain investors.
Bonds Versus Real Estate
Bonds, another investment vehicle that many conservative investors consider, can be more secure than stocks. When a company has available cash to distribute, bondholders are paid before any dividends are issued to stock investors. However, bonds only offer regular interest payments to their investors. There is no ability to experience any appreciation from bonds.
In contrast to either value- or growth-oriented stocks and bonds, real estate generally provides investors with BOTH cash dividends (through rents) and appreciation. It is this unique feature to real estate that leads most investors to add it to their investment portfolio.
Creating a Well-Balanced Portfolio with Real Estate
A well-balanced and diversified investment portfolio is like a three-legged stool. One leg represents stocks, the second one bonds, and the third leg is real estate. Real estate provides portfolio diversification that would otherwise be absent when your portfolio consists of only stocks and bonds. Part of the reasoning behind this is the fact that real estate pricing is determined and impacted at a local level, whereas pricing for a particular stock or bond is established uniformly. Every property is unique, whether in style, location, or functionality, but wherever one purchases a bottle of Clorox or a McDonald’s burger, the product is the same.
From a long-term perspective, real estate offers investors historically good performance. Since the construction process is detailed and laborious in many jurisdictions, it can often take many years from conception to completion. As a result, real estate values can be insulated because adding new supply is difficult. Second, since real estate investments frequently utilize financing, often at extremely low rates (i.e., current commercial interest rates can range from 3.5% to 4.0%), which can significantly enhance an investor’s returns.
Another uniqueness of real estate compared to stocks or bonds is that land is finite. There is only so much of it and in some markets, particularly on the east and west coasts, there is so little developable land, prices have been steadily increasing. This is going to become even more apparent in the coming decades as our population continues to grow.
There are also significant tax advantages for real estate investors. The two major advantages are depreciation and tax-deferred like-kind exchanges. Neither of these options is directly available to stock and bond investors. Depreciation permits an investor to deduct a portion of the property’s purchase price over a specified number of years. This can help some investors shelter net profits from rents. The second advantage is the ability to defer capital gains upon sale by investing the proceeds in another real estate investment. These two tax benefits can provide investors with a significant advantage over stocks and bonds over time.
Want to read more about how investing in commercial real estate can enhance your portfolio? Would you also be interested in seeing how Kenwood’s real estate returns compare to the S&P 500’s?