As the equity markets continue to soar to new heights in the eighth year of the current bull market, many investors are asking themselves just how long it can continue. Concerns about unrealistically high valuations and geopolitical risk are causing some investors to rethink just how much of their portfolios they want allocated to stocks.
Even with the Federal Reserve slowly raising interest rates, the yield on Treasury bonds and other traditional fixed income instruments remains well below the level most investors expect to receive. Interest rates are also holding down the yield on corporate bonds, which can have the disadvantage of being so highly correlated to equity performance. Investors in that sector are being forced to take on additional risk, either in terms of credit or duration to boost yields.
That brings us to alternative investments, which can provide diversification that is not correlated to the performance of the stock and bond markets. There is a wide range of alternative strategies and vehicles that advisors can add to client portfolios, and some of them — real estate and marketplace lending, among others — can provide investors with steady income streams with higher yields than traditional fixed income.
A recent survey by Tiger 21 revealed that high-net-worth investors have been moving more of their assets into real estate. In fact, those surveyed had an average of 33% of their portfolios in real estate.
Historically, real estate investors have also benefited from the appreciation of the underlying properties, in addition to a current income stream. As with any investment, however, there is always the possibility that values could fall, so investors should do their due diligence.
The most direct ways for individuals to get into the real estate market often require a great deal of hands-on involvement in order to get the most benefit. One option, made popular on cable TV shows like “Flip That House,” is to buy a fixer-upper to renovate and resell, or “flip.” While some people have made money from this approach, if your clients don’t have the skills to do much of the work themselves the payback is not as large. Another option is to buy either a single or multi-unit property for rental. But in becoming a landlord, the investor takes on risk from vacancy or bad tenants, unpredictable maintenance expenses, and the time commitment it takes to manage the property. Additionally, when such real estate is held in a retirement account, advisors and their clients should be aware of the potential for an IRS-prohibited transaction.
It can be much simpler for advisors to get their clients into real estate by investing directly in an equity real estate investment trust listed on a public stock exchange or through a REIT mutual fund or ETF. When investors add real estate to their portfolios through either public or private funds, such as REITs, they can reduce the inherent risk and hassle of researching and managing either individual properties or loans.
Data from the National Council of Real Estate Investment Fiduciaries and The Townsend Group show that “stock exchange-listed equity REITs, on average, outperformed private equity core, value-added and opportunity funds,” and that, “over the full market cycle, equity REITs delivered a compound annual total return, net of fees and expenses, of 13.4% – significantly better than the 7.7% of core funds; the 8.9% of value-added funds; and the 12.9% of opportunity funds.”
There are many types of REITs available, so advisors have a range of options to find the right solution for each client. Some are diversified across multiple property types and others are specialized in a particular kind of real estate — retail, residential, offices, health care, self-storage and hotels to name a few.
Advisors could also consider the increasing number of alternative platforms specializing in real estate investments, which give advisors numerous options for adding real estate to client portfolios. These include funds that provide access to private market, direct investment strategies and crowdsourcing platforms for residential and commercial real estate lending. Both of these options allow advisors to help their clients participate in the types of high-quality real estate deals that previously have only been open to the highest net-worth investors, family offices and institutions.
Ultimately, the goal of these alternative real estate investment platforms is to use technology to simplify real estate investing. Rather than being limited to what’s available locally, advisors can now easily create geographically diversified real estate portfolios that allow clients to reap the benefits of a sustainable and predictable income stream, while avoiding the hassles and paperwork that usually come with being a landlord.
And don’t forget that investors can tap into the power of their retirement funds by using a self-directed IRA to invest in real estate. Advisors should work closely with their clients to help them navigate the ins and outs, and avoid prohibited transactions.