Exploring Alternatives: Real Estate As An Alternative Investment
Many investors seek portfolio diversification to mitigate risk and optimize returns. Alternative investments, which fall outside of traditional stocks and bonds, have gained prominence for their potential to enhance portfolio stability and yield. Real estate, in particular, stands out as a robust alternative investment option, offering unique advantages and challenges that appeal to a wide range of investors.
In this blog post, you will learn about real estate as an alternative investment, the advantages and disadvantages, and if alternative investments are right for your portfolio and risk tolerance.
Real estate as an alternative investment
Real estate—including private equity and private debt—is a very popular form of alternative investment. Depending on the asset class, real estate is considered a less risky alternative investment. Unlike more volatile assets such as commodities or venture capital, real estate typically offers steady income generation opportunities.
Single and multi-family properties, commercial buildings, industrial spaces, and even agricultural land are examples of real estate investments with varying risk profiles and return potential.
Real estate investment trusts (REITs) also fall under the alternative investment category. A REIT is a company that owns, operates, or finances real estate properties that generate income. As an investor in a REIT, you will not have to commit time to actually managing the property, but you will still gain exposure in your real estate portfolio.
5 benefits of investing in real estate
There are many benefits to investing in real estate, especially for investors who are interested in diversifying their portfolios and generating stable returns. Some of the advantages to investing in real estate include:
- Passive income: One of the main reasons investors are interested in real estate is the opportunity to generate passive income, which is the ability to generate regular and predictable cash flow that doesn’t come from your full-time job. Rental properties are perfect examples of passive income as they provide ongoing rental income you can rely on. The passive income from the rental property can be used to cover mortgage payments, maintenance costs and renovations, and generate overall cash flow.
- Lower volatility: Real estate values tend to be less volatile than stocks, offering a ‘cushion’ during economic downturns.
- Portfolio diversification: Real estate is often not affected by the performance of stocks and bonds which makes them an effective diversification tool. When stock markets are volatile and unpredictable, having real estate investments in your portfolio can provide stability and reduce the overall risk of your portfolio. To further take advantage of the benefits of diversification, investors should consider investing in different types of real estate (residential, commercial, etc).
- Portfolio hedging: Real estate can help manage portfolio risk by hedging against inflation and economic cycles. Property values and rents typically increase with inflation, preserving the real value of the investment. Real estate also often performs differently than other asset classes during economic cycles, providing further portfolio stability.
- Flexibility: With real estate, the sky’s the limit. Real estate investments offer a level of flexibility that’s unique among asset classes. Investors can select from various properties that fit their needs and goals, whether it be a fixer-upper or a ready-to-go space.
Real estate offers many benefits, making it a compelling investment option for investors looking to build long-term wealth and achieve financial stability.
4 disadvantages to investing in real estate
While investing in real estate offers numerous advantages and opportunities for investors to reach their goals, there are also some disadvantages to consider.
- Market liquidity: Compared to stocks and bonds, real estate investments are less liquid, which refers to how easily or quickly an asset can be converted into cash. Selling a property can take time, especially during economic downturns or less desirable market conditions. The location of your property will be a pivotal factor in how quickly it will likely sell. The lack of liquidity can limit an investor’s ability to quickly access cash or adjust their portfolio in response to financial needs, goals, or market conditions.
- Initial capital: Purchasing a property often requires a substantial amount of upfront capital, which can be a challenge for many investors. Depending on the property, your initial investment may be over $100,000 or more. The down payment is just the big ticket cost, you will also have to factor in closing costs, ongoing maintenance, and improvement expenses.
- Cyclical market: Real estate markets are cyclical by nature and sensitive to economic conditions. During economic downturns or periods of high interest rates, property values can plummet, impacting the potential for capital appreciation and/or rental income. When this happens, investors may be subject to holding onto properties that are worth less than the mortgage owed or face decreased rental demand, which drastically impacts cash flow and investment returns.
- Valuation: Valuation is a significant challenge when investing in real estate. There are many factors to consider, including location, market trends, and demand. Accurate data is critical for conducting market analysis, comparing similar properties, and applying valuation methods.
Understanding and managing these disadvantages is crucial for investors considering real estate as part of their investment portfolio. While real estate can offer significant potential returns and diversification benefits, it requires careful planning, risk management, and ongoing oversight to navigate its complexities effectively.
Investing in Real Estate: Is It The Right Opportunity For You?
The world of real estate investing comes with various opportunities and challenges for investors. While these investments offer many benefits, including inflation protection, portfolio diversification, and generating passive income, they also come with risks. Before you commit to any investment, consider 4 things:
- Time horizon: How long do you want to hold onto an investment? Depending on the market and your financial goals, you may need to hold onto a real estate investment for a significant period of time. You may need to reconsider your investment strategy if you already have multiple investment switch long time horizons in your portfolio.
- Diversification: A well-diversified portfolio holds investments from multiple industries, markets, and asset classes. For example, if you’re already investing in multi-family homes but want to continue investing in real estate, explore other avenues, like commercial properties.
- Risk: How much risk are you willing to take on in your portfolio? Risk is present in all investments, but some are certainly more risky than others. Think about your financial and investment goals before committing to a new investment.
- Education: Real estate is an ocean of opportunity, so it’s important to seek out lessons and advice from other investment professionals. Not all education is created equal, but organizations like RE Mentor provide comprehensive real estate education so investors of all experience levels can deepen their financial knowledge and take the real estate world by storm.
Effectively investing is serious business, so we always recommend consulting a professional. If you need recommendations on financial professionals or are interested in Hedgehog’s alternative investment model, get in touch with our team.
Disclaimer:
This material is intended for informational purposes only and should not be construed as legal or tax advice. Information here is not intended to replace the advice of your investment advisor or financial advisor. This information is not an offer or a solicitation to buy or sell securities. This information may have been compiled from third-party sources and is believed to be reliable. All investing involves risk, including the loss of principal.