Direct investments in real estate offer a number of advantages and disadvantages relative to other asset classes.
- Tax subsidies for certain expenses (depreciation, mortgage interest)
- Access to low-cost financing via mortgages (improved leverage)
- The ability to take action related to property management confers a control premium
- Owning multiple properties can confer geographic diversification
- Compared to equities, real estate returns are less volatile
- Properties often cannot be divided, so each can represent a large position within the portfolio
- Uniqueness of properties results in high costs for gathering information
- Brokerage commissions are high
- Operating and maintenance costs are high, and special expertise is often needed
- Potential risks such as neighborhood deterioration can be outside the owner’s control
- Tax advantages are subject to political risk
Posted on 27th March 2008
Under: Active Management, Alternative Assets, Investing in Real Estate, Investment Returns, Portfolio Management | No Comments »
Real estate offers significant benefits to a diversified investment portfolio. These include:
- A low correlation with the returns on investments in stocks and bonds, which improves the overall diversification of a portfolio.
- Income enhancements from property rental offer a stable revenue stream and reduce return volatility.
- REITs have a higher Sharpe ratio (risk adjusted return) than stocks or bonds.
- A low correlation between real estate investments (geographic and sector diversification within real estate).
Although real estate improves diversification relative to a portfolio of stocks and bonds, it has demonstrated less benefit when added to a portfolio that also includes hedge funds or commodities. The diversification benefits may be redundant to those of other alternative asset classes.
Investing in real estate also poses special due-diligence concerns, including the valuation method, financing opportunities, legal issues such as zoning and title checks, and taxes.
Posted on 27th February 2008
Under: Alternative Assets, Institutional Investing, Investing in Real Estate, Investment Returns, Portfolio Management | No Comments »
Investments in real estate have a number of characteristics that distinguish them from other asset classes.
As an asset with intrinsic value, real estate poses advantages over some alternative investments such as commodity trading or hedge funds. In addition, rental income provides a stable revenue stream that improves overall stability of returns.
Against these benefits are a number of specific risks:
- Illiquidity – it can often take months or more to sell a property
- High transaction costs – significantly higher legal and brokerage fees than apply to other asset classes
- Heterogeneity – each property is different, requiring specialized analysis
- Immobility – location, location, location
- Low information transparency (the seller has much better information than the buyer)
Real estate values are driven by population growth and interest rates. There may be some inflation hedge inherent to real estate, but empirical studies have produced mixed results on this front.
Posted on 27th January 2008
Under: Alternative Assets, Investing in Real Estate, Portfolio Management | No Comments »
There are a number of benchmarks available to gauge the relative performance of real estate investments.
The National Council of Real Estate Investment Fiduciaries (NCREIF) Property Index is a useful comparison for direct real estate investments. It is a value-weighted index with data reported quarterly. It measures non-levered return, which may be more representative of private real estate funds. One consideration is that its use of appraisals can lead to stale valuations and the appearance of smoother return performance than is actually realized.
The NAREIT index is a useful benchmark for indirect real estate investments. It provides a real-time, cap-weighted performance measure of levered returns. The inclusion of leverage and more frequent measurement contribute to a higher standard deviation of returns than is observed by the NCREIF index.
Posted on 27th December 2007
Under: Alternative Assets, Institutional Investing, Investing in Real Estate, Portfolio Management | No Comments »