Written By: Brian McKinney, CFP®
Including asset classes in a portfolio that have low correlations to stocks is a great way to reduce portfolio volatility. Unfortunately, most traditional assets such as various equity segments, lower-quality bonds, and even public real estate are more closely correlated with stocks than most people think.
Private nontraded real estate funds have historically low correlations to both stocks and fixed income while providing exposure to the third-largest asset class after stocks and bonds, commercial real estate. Historically, commercial real estate has been one of the primary ways large institutional investors have diversified their portfolios. Now, these alternative investments are becoming more widely available to retail investors.
A Brief History of Investing in Commercial Real Estate
For centuries, commercial real estate investing has been the domain of institutional investors, such as financial institutions and large corporations. According to LaSalle Investment Management, today, institutions own about $10.2 trillion in commercial real estate, which is favored due to its diversification benefits. Historically, approximately two-thirds of the long-term returns from equity real estate come from distributions.
Now, through the advent of real estate investment trusts (REITs), retail investors can benefit from similar access to commercial properties by investing alongside institutions with pooled money.
The commercial real estate market opened to retail investors in the early 1960s with the release of the first real estate investment trust (REIT). REITs are specially formed corporations afforded unique tax benefits that help level the playing field for retail investors who want to capitalize on the income and wealth-building power of commercial real estate.
Real Estate Investors Have a Choice
Investing in Real Property
Of course, investors can invest directly in properties, deriving their returns through rental income and capital appreciation. This method of obtaining real estate exposure can be very high risk, capital intensive, typically involves the use of leverage, and may require a long-time horizon to produce returns.
Alternatively, investors can pool their capital and invest alongside an institutional investor with the expertise and reach to diversify its portfolio among several properties. That can be accomplished through a traded REIT or non-traded REIT.
Publicly-traded REITs are bought and sold on a stock exchange like any other stock, which means they are highly liquid. Chances are if you invest in a diversified stock fund, you likely already have exposure to some REITs as they currently make up approximately 3% of the US market. Within the realm of real estate investing, there are hundreds of traded REITs investing in various types of properties and mortgages.
There are two types of non-traded REITS—private REITs and public REITs.
Investments in non-traded private REITs can only be made through private placements or direct solicitation of investors. They generally have very high minimum investment requirements and strict holding requirements, with five- to ten-year holding periods before you have access to your investment (not including distributions). Private REITs are not subject to Securities and Exchange Commission (SEC) oversight.
Public non-traded REITs are registered with the SEC, and they offer shares, but they are not traded on stock exchanges. Historically, they have had high investment minimums and offer limited options for share redemption. However, over the last decade, a new investment structure has emerged – Daily NAV REITs. The benefits of this new structure are access to non-traded REITs with greater liquidity and transparency to investors than prior versions commonly referred to as life cycle funds.
Publicly-Traded REITs vs. Non-Traded REITs
If you’re a high-net-worth investor with disposable capital and a long-term time horizon, you might consider including non-traded REITs in your portfolio for their higher yields, diversification benefits, and expert management.
On the other hand, if greater liquidity by owning an individual stock, mutual fund, or exchange-traded fund is your preference, publicly-traded REITs may be a better option. Keep in mind that publicly-traded REITs are already owned by many US stock mutual funds and you may unknowingly duplicate exposure.
As you can see, between the many options available in real estate investing, this asset class can offer benefits to your overall portfolio strength. In choosing if investing in real estate is right for you, all factors should be considered including your risk tolerance, goals, and liquidity needs. A financial advisor can help you determine if real estate investing makes sense for your specific situation and what options may be available to you.
A nontraded real estate investment trust (REIT) is a REIT that is not traded on any public stock exchange. Nontraded REITs are generally illiquid securities for which no public market exists. As such, investors may be unable to liquidate the security at any price. You should consult with your financial advisor and carefully consider your short-term and long-term liquidity needs. Real estate investments are subject to a high degree of risk because of general economic or local market conditions; changes in supply or demand; competing properties in an area; changes in interest rates; and changes in tax, real estate, environmental, or zoning laws and regulations. Real estate units/shares fluctuate in value and may be redeemed for more or less than the original amount invested. There is no assurance that the investment objective will be attained.
Real estate investments are subject to a high degree of risk because of general economic or local market conditions; changes in supply or demand; competing properties in an area; changes in interest rates; and changes in tax, real estate, environmental, or zoning laws and regulations. REIT units/shares fluctuate in value and may be redeemed for more or less than the original amount invested. There is no assurance that the investment objective will be attained.