Portfolio investors, particularly the savvier individuals, are paying attention to the economic climate and wanting more from their investment portfolios through alternative real estate investments.
But the alternative doesn’t necessarily mean added risk or instability. Real estate investments are becoming increasingly demanded as a way of diversifying portfolios and leveraging shifts in our economy. Registered Investment Advisors (RIAs) are finding themselves in a position where understanding and leveraging the potential of real estate investments is crucial.
Family offices have long understood the value of real estate, which offers long-term growth, downside protection, and helps preserve wealth.
As we saw throughout the Covid-19 pandemic, real estate assets (the office sector aside) are incredibly resilient. With slowing job growth, continuing high inflation, and a high-interest rate environment, there’s no telling what the future will bring. However, what is certain, is that housing will always be needed, and the US housing market is short 6.5 million homes. As a result, the residential real estate market offers outperforming investment options.
It’s time for RIAs to follow the lead of family offices and begin exploring alternative investments in the real estate sector.
Why Real Estate Investments?
Historically, RIAs have been hesitant to recommend real estate to their clients due to perceived challenges such as long-term commitment, illiquidity, high minimum investment levels, and reporting complexities.
But the investment landscape is changing, with more clients expressing interest in real estate. They are catching on to the benefits of diversification and the long-term wealth benefits of property.
Hedge Against Inflation
In times of economic uncertainty and potential inflation, residential real estate investments serve as a solid safeguard. There is a strong correlation between inflation and housing prices, making it an exceptional investment vehicle to hedge against inflation.
The reason for this lies in the distinct attributes of real estate:
1. Appreciation of Property Value
Real estate prices generally rise in line with, or faster than, inflation. This means that the real value of an investor’s asset remains steady, even in times of high inflation. If you invest in a property today, and assuming there are no “black sheep” events, you can expect its market value to be considerably higher in the future due to the dual forces of demand growth and inflation.
2. Rental Income Growth
When inflation is high, more money floods the market, which drives up market rental rates and benefits landlords. If a property is already tenanted, landlords can increase rents periodically. These rent hikes are often indexed to inflation (the same benefit can’t be said for stocks). As costs of living rise, so does the income generated from real estate investments, preserving the purchasing power of the income generated by the property.
3. Inflation-Indexed Debt
Unlike other investments, real estate is unique in that it can be leveraged, meaning you can buy a property using borrowed money. When inflation rises, the real value of debt decreases. Properties purchased purchase a property; the mortgage payments stay the same in nominal terms over time. However, as inflation increases, these payments become less burdensome in real terms as the purchasing power of the currency (e.g., the dollar) diminishes. This aspect of depreciating debt provides an additional hedge against inflation.
4. Replacement Cost Value
As inflation increases, so does the cost of materials and labor needed to build new properties. This can make existing properties more valuable as they cost more to replace in the future, contributing to the appreciation of property values during inflationary periods.
Attractive Returns
Real estate, especially value-add projects and development syndications, can provide attractive potential returns to investors, further driving their appeal.
The primary source of returns is your rental income. In a well-managed property, cash flow can be substantial and steady. The ongoing monthly or annual income provides investors with a consistent revenue stream, which can be particularly attractive in uncertain economic times.
But rental income isn’t necessarily where wealth is generated. That comes from value-add and long-term holding of real estate assets, which lead to value appreciation. Strategic improvements or developments, shifts in the local real estate market, broader economic growth, or the simple passage of time can all contribute to the appreciation of a property’s value.
And lastly, real estate investing comes with added tax benefits, including:
- Depreciation.
- 1031 exchanges to defer capital gains tax.
- Additional deductions for operating and capital expenses.
Portfolio Diversification
Real estate assets offer RIAs a powerful tool for diversifying their clients’ portfolios. Given the relatively low correlation between real estate and traditional investment assets such as stocks, bonds, and commodities, RIAs can mitigate risk and possibly enhance returns through real estate.
How Can RIAs Incorporate Real Estate Investments?
There are several paths that RIAs or independent investors can take to integrate real estate into their clients’ investment strategies, each of which has its own advantages and disadvantages.
Direct Ownership
Becoming a landlord is not for those who want to be passive investors but who want to dive into the real estate market with full force. Clients can directly invest in properties either individually or through their retirement accounts to become landlords themselves. While this offers a high degree of control, it also comes with the responsibilities and challenges of property management.
Partnering with Operators
Investors can join forces in a single property alongside a real estate operator, such as a real estate syndication. This approach allows investors to benefit from the operator’s expertise while still having all the benefits of ownership.
Investors can also participate in private funds that have varying goals from income to growth, with some of the more sophisticated operators like Fish Capital Investments. These funds can help balance a portfolio while providing diversification across multiple real estate assets and strategies.
RIAs should start forming relationships with experienced operators with long-term investment strategies. They offer access to otherwise unobtainable assets, professional management, detailed reporting, and a hands-off investment approach without sacrificing returns.
Real Estate Funds and REITs
REITs and funds are attractive assets for RIAs and their clients. They offer some of the best features of real estate without the heavy illiquidity and burden. These vehicles pool investor funds to invest in a diversified portfolio of real estate assets, providing the following benefits:
- Inherent diversification.
- Professional management.
- Accessibility with lower buy-in amounts.
- Higher liquidity than direct ownership but more liquidity restraints than stocks.
- Dividends or cash flow payouts.
- A variety of options, operators, and funds.
Navigating Client Preferences
Investors’ preference shift is creating a heightened demand for alternative investments, which presents new opportunities in real estate. However, RIAs must familiarize themselves with this asset class, assessing which real estate investments are most secure, profitable, and suitable for their clientele.
As we push through uncertain economic times, the trend of including real estate investments in RIA portfolios will continue.
Each investment vehicle comes with corresponding advantages and disadvantages. It falls into the hands of RIAs to educate themselves about the offerings in the market.
Firms like Fish Capital are ready to support RIAs in serving their clients through education and offering a range of alternative real estate investment options to suit their client’s needs.
For RIAs, the time to explore and embrace the possibilities of real estate investments is now. As clients seek diversification, better returns, and protection against inflation, real estate investments can prove a key asset in fulfilling these objectives.
