From outcast to homecoming king, real estate is popular again. But how (and should) this asset class be part of your long-term investment strategy?
The Dow Jones Global Real Estate Index – a measure of commercial, residential and REIT returns throughout the investable world – returned almost 13.5% in 2014. Meanwhile, residential home prices in the U.S., as calculated by the Case-Shiller index of the country’s 20 largest markets, increased by double-digits percentages on a year-over-year basis during 2014. But how and, more importantly, should this asset class play a role in your portfolio?
First, let’s examine why an individual would choose to incorporate real estate as a piece of the investment pie:
- Diversification – Though real estate often moves in similar fashion to stocks, that is not always the case. Real estate has different sensitivity to interest rates, can be affected by disparate economic events, and is aided by a historically robust yield.
- Access – Diversified real estate funds provide exposure to a wide variety of investments, many of which are often difficult for individual investors to obtain. For example, a fund can invest in commercial buildings, retail shopping space and even esoteric corners of the marketplace such as storage facilities.
- Your Primary Residence is Not an Investment – In our last blog post, we tackle this issue head-on and conclude that a home is most often not an investment. Incorporating a real estate fund into a portfolio ensures this asset class is adequately captured.
As with any investment approach, there are considerations to keep in mind:
- Volatility – Individual sectors will have their ups and downs. A real estate allocation should be viewed not on its own, but as part of a larger diversified portfolio.
- Long-Term – The bumpier ride inherent in owning individual sectors means investors must accept that holding real estate is a long-term decision. The same is true of an investment in commodities, small company stocks or emerging markets debt.
- Not All Funds Are Equal – The specific focus of a fund can vary; look closely to understand the fund’s explicit strategy and holdings. If a fund follows an indexing approach, the investor needs to know how the index is constructed, what it tracks, and how the fund trades underlying securities.
- Set a Minimum and Maximum – A specific sector should never exceed a designated percentage within a portfolio. Select a target range, selling when it surpasses a maximum threshold and buying when it falls below a minimum. In doing so, this volatile asset class will never overwhelm the portfolio.
- Outside Real Estate Investments – If you already hold significant real estate investments outside of your portfolio – for example, through limited partnerships, private trusts, or income properties – an additional investment may not be appropriate.
Real estate can play a meaningful role in diversification and long-term returns. We hope this post helped you to begin sifting through the noise of this frequently discussed asset class.
Check back in two weeks for the final installment of our real estate series – Vacation Homes: Better to Buy or Rent?