Real estate investment is the purchase of a future income stream from property and can offer several advantages over other types of investments, including potentially higher returns, stability, inflation hedging, and diversification. Here are some of the key reasons to consider investing in real estate.
High Tangible Asset Value
Unlike stocks, and to some extent, bonds, an investment in real estate is backed by a high level of brick and mortar. This helps to reduce principal agent conflict or the extent to which the interest of the investor is dependent on the integrity and competence of managers and debtors Even real estate investment trust which are listed real estate securities, often have regulations that mandate a minimum percentage of profits be paid out as dividends. Paper assets are a risk. Your dollars are not even accessible at the bank it’s turned into electronic digits. Stocks are risky. As a hard asset, real estate has meaningful value in ways other investments don’t. If my real estate burns down, insurance covers it. Real estate does not have red and green days like the stock market, which is important because you never want to lose money!
Attractive and Stable Income Return
A key feature of real estate investment is the significant proportion of total return accruing from rental income over the long term. This helps reduce volatility as investments that rely more on income return tend to be less volatile than those that rely more on capital value return. Real estate is also attractive when compared with more traditional sources of income return.
Portfolio Diversification
Another benefit of investing in real estate is its diversification potential. Real estate has a low and in some cases negative, correlation with other major asset classes. This means the addition of real estate to a portfolio of diversified assets can lower portfolio volatility and provide a higher return per unit of risk.
Inflation Hedging
Rents usually increase with inflation, while mortgage payments on the property remain stable. This increases cash flow, without the increased expense of holding the property. When inflation goes up, it can also mean more renters as mortgages become more expensive for average consumers. More renters increase demand, so rents can escalate. Over time, inflation, which is considered the hidden tax, enters into the economy, reducing your purchasing power. You can make the same amount of money today as 20 years ago and see you have less money left over. However, the right real estate investments have historically provided excellent appreciation in value because the property value is based on rents increasing not just property values!
Cash Flow
Cash flow secures the assets meaning the income provided by renters should exceed the cost of operating the property leaving enough cash to pay debt and provide investors with a positive return on their equity (cash). This provides a regular income stream that is significantly higher than the typical stock dividend yield!
To sum up, Real estate is a distinct asset class that is simple to understand and can enhance the risk and return profile of an investor’s portfolio. On its own, real estate offers competitive risk-adjusted returns, with less principal-agent conflict and attractive income streams. It can also enhance a portfolio by lowering volatility through diversification. Though illiquidity can be a concern for some investors, there are ways to gain exposure to real estate yet reduce illiquidity and even bring it on-par with that of traditional asset classes.