After the economic recession of 2008, many people avoided investing in real estate. This was because this era was often linked with the housing bubble and subprime mortgages. But the truth is, real estate is a smart asset class to invest in. When you invest in real estate, you are purchasing a future income stream from property. It is in reality quite unfair that real estate investment is given a bad reputation. Here are a few reasons to invest in real estate:
- You can diversify your portfolio.
Investing in real estate can give you incredible potential to diversify your portfolio. The correlation between real estate and other major asset classes is low, and in some cases, negative. This means that if you add real estate to your portfolio of diversified assets, the portfolio can decrease in volatility. This can also provide higher return per unit of risk.
2) The income return is attractive and stable.
One big upside to real estate investment is the sizeable proportion of total return, accruing from rental income over the long term. Between 1977 and 2007, about 80 percent of total U.S. real estate return came from income flows. This leads to a decrease in volatility. Investments that rely more heavily on income return have a tendency to be less volatile than those that rely more heavily on capital value return. In addition, real estate is more attractive than more traditional sources of income return. The asset class usually trades at a yield that is premium to U.S. Treasuries. It is especially attractive in an environment with low Treasury rates.
3) It has competitive risk-adjusted returns.
Data from the National Council of Real Estate Investment Fiduciaries (NCREIF) shows that over the 10-year period from 2000 to 2010, private market commercial real estate returned 8.4 percent on average. This has a lot to do with low volatility relative to equities and bonds. Many critics feel the the reason real estate has a low volatility is that real estate transactions have not been frequent. As a result, property values are often determined using third-party appraisals, which often cause the market to lag. As a result of infrequent transactions and appraisals, there is a smoothing of returns. In an upturn, reported property values tend to underestimate market values. In a downturn, they tend to overestimate market values.
Real estate volatility should be adjusted upward, but real time markets could undergo sudden shocks at any moment. One example of this occurred during the “Flash Crash” of May 2010. In just 15 minutes, $1 trillion in stock market value was erased. When market volatility is an issue and the dynamics of algorithmic trading are murky, real estate is an attractive investment due to its more stable pricing.
While many people will tell you that investing in real estate is a bad idea, this is in many ways a myth. With a stable income return and the potential to diversify your portfolio, real estate is a worthwhile investment.