The Role Of Real Estate Investment In Portfolio Diversification
The one rule of real estate investing that is critical for all is -"Do not put all your eggs in one basket". The reasoning: If a farmer trips while bringing the basket of eggs back from the henhouse, they could end up in a sticky situation. These words of wisdom extend far beyond farming; they perfectly encapsulate the concept of not putting all of your money into a single investment. Diversifying the portfolio is one way for investors to reduce the risk of a shattered nest egg. But, how do we diversify? You can do so through real estate investment.
Are you squandering money? Some experts believe that if you do not diversify your portfolio over numerous asset classes, including real estate, you are essentially throwing money away in the long run. You are overexposing yourself to risk with each market fall. As a result, you will be less likely to achieve your financial objectives. Diversification is undeniably vital. Warren Buffett, the legendary investor, has advice for anyone looking to get the most from a long-term investment strategy. He likes to say that diversification is “protection against ignorance.” Real estate is one of the things you should consider if you want to diversify. Incorporating real estate into your financial portfolio provides several advantages. Real estate is a critical component of diversified portfolios because it can provide income, capital appreciation, inflation protection, and diversification.
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What exactly is portfolio diversification?
Portfolio diversification is a risk management approach that entails investing in asset classes to reduce loss exposure and enhance earning possibilities. (We are trying hard not to use the old metaphor of placing all your eggs in one basket, but it is difficult to ignore). Diversification, however, extends beyond investing in diverse Indian and foreign stock funds, as most professional advisers advocate, because all of that money is in the equities market basket. It is where real estate enters the picture.
A diverse portfolio is like a solid foundation that helps your assets withstand disruptions, just as a solid foundation helps a skyscraper stand firm in all conditions. The same set of risks will not affect different types of assets in different markets. Diversification strategies are not all created equal. Effective diversification entails looking beyond the stock markets and traditional securities investments. Buying stocks in industries or indexes may give the appearance of diversification, but it is unlikely to protect your assets in a down market. Financial markets are highly correlated. It means that when stocks fall, they all fall with them. When the market crashes, there is usually a ripple effect, and markets crash globally. But, real estate is a tangible asset. It is a real, tangible asset. A stock market crash or an industry disruption may completely deplete equity, rendering some of your stock holdings worthless in perpetuity. Under the same conditions, a commercial or residential property may pay less until the economy recovers, but it will continue to exist as an asset.
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Why real estate?
“Why do investors add real estate to their portfolio” is a commonly asked question. Real estate is a fundamental component of investment portfolios, acting as a buffer against the volatility of stock market returns, rising interest rates, and inflation. Income from long-term lease contracts can be a significant component of real estate returns at a time when investors are looking for yield. Furthermore, the long-term growth potential of real estate benefits from megatrends such as aging populations, urbanization, and rapid development in India.
Unlike other assets, it appears that real estate and real estate diversification pay off at a time when the benefits are most needed, i.e. when consumption growth opportunities are limited. The returns on real estate are predictable. The predictability of real estate returns appears to be roughly the same as that of stock returns. In an asset-liability framework, real estate performs well. The likelihood of suffering a large loss on real estate over a long time horizon is quite low.
For many years, the 20% Rule has been popular. This method, devised by Yale’s Investment Office’s David Swenson, entails diversifying at least 20% of your portfolio into alternatives to the stock market – often, real estate. For example, a sample portfolio based on the 20% rule would look like this:
- 30% of the stocks are domestic.
- Bonds and securities comprise 30% of the total.
- 20% of the budget is allocated to real estate.
- 15% of overseas developed markets
- 5% for developing markets
However, opinions differ. Some experts advise spending only 15% of your portfolio on real estate while expanding your investment in other alternative asset types. It will be determined by current economic conditions and what is ideal for your financial situation.
How to build a real estate portfolio?
Real estate is among the most profitable asset classes, and it’s an excellent approach for any investor, including those who emphasize stocks, to diversify their portfolio. You may diversify your real estate portfolio in the same manner that you would diversify your stocks portfolio: you will invest in several asset classes. In other words, you will invest in a variety of assets.
- Commercial Real Estate: Commercial real estate investing is the most appealing investment choice. This is because regardless of market uncertainty, commercial real estate investing delivers a continuous stream of cash flow and asset appreciation. It is favored by investors who are skilled in asset management and do not want quick financial gain. Commercial real estate, once bought, maybe a very profitable and stable source of cash for the foreseeable future. Commercial property ownership consists of office buildings and factories. However, because of the high quantities of money required, CRE has remained in the arena of Ultra HNIs and HNIs. So, an average investor’s only options are erratic stocks and FDs.
- Real Estate Crowdfunding: Investing in real estate used to be a lofty ambition for the average investor. However, this is no longer the case. Real estate crowdfunding is an innovative way for investors to pool cash for a real estate project. Initially, they gain money from leasing revenue. Furthermore, crowdfunding allows investors to participate and invest in premium commercial real estate developments without having to manage the property. In most situations, the crowdfunded property is controlled by an operator, and all an investor needs to do is spend their money to support the endeavor.
- Fractional real estate ownership: Fractional ownership is the sharing of ownership of a premium office space with a minimum of Rs.10 lacs by unknown persons. In addition, investors can divide the revenue and expenses connected with this asset in proportion to their investment. Investors can diversify their portfolios by owning a portion of the property such as commercial office spaces or shopping malls. It is the ideal investment because all members share the property’s expenditures, revenues, and financial obligations. In terms of rental revenue and capital appreciation, fractional ownership ensures returns and expanding return rates.
- REITs: A real estate investment trust (REIT) is a firm that invests in revenue-generating real estate. A REIT will frequently invest in a large number of real estate properties. Mutual funds and real estate investment trusts (REITs) are both types of REITs. The major contrast is that REITs, as opposed to stocks and bonds, hold commercial, residential, or industrial property or mortgage securities. As a consequence, real estate investment trust (REIT) investors would get rental income, gains from sold properties, or payments on mortgage-backed securities loans. REITs can provide capital gains as well, but the monthly dividend income is generally the most enticing aspect. The REIT’s earnings are likewise not subject to income taxes. They give out 90% or more of their income in dividends to their shareholders.
Incorporating real estate in a mixed-asset portfolio provides important diversification and inflation hedging benefits, possibly improving the portfolio’s risk-adjusted returns. With the correct asset mix, a well-built real estate portfolio may also provide a relatively constant income stream despite market ups and downs. Investing in real estate carries major risks, which may be mitigated by diversifying the portfolio across many regions and property kinds.
Real estate is an excellent investment vehicle. A middle-class investor, on the other hand, may find it difficult to diversify and acquire many houses. They may readily diversify, though, by using real estate platforms such as Assetmonk. They can engage in fractional ownership and crowdfunding as viable investment choices that allow for regional diversification. Assetmonk, a prominent GrowthTech platform in India, provides Grade-A real estate properties at cheap costs to its clients, with an annual IRR of up to 21% guaranteed. It encourages investors to diversify their portfolios. Moreover, you may seek guidance from our specialist asset and property experts.
Real Estate Investment Diversification FAQ'S
The proportion of real estate in your investment portfolio should be 20%.
Real estate and real estate diversification pay off at a time when the benefits are most needed, i.e. when consumption growth opportunities are limited. The returns on real estate are predictable. The predictability of real estate returns appears to be roughly the same as that of stock returns. Real estate performs well in an asset-liability framework. The likelihood of suffering a massive loss on real estate over a long time is low.