About Ian Ippolito
Ian Ippolito is an investor and serial entrepreneur. He has been interviewed by the Wall Street Journal, Business Week, Forbes, TIME, Fast Company, TechCrunch, CBS News, FOX News and more.
Ian was impressed by the potential of real estate crowdfunding, but frustrated by the lack of quality site reviews and investment analysis. He created The Real Estate Crowdfunding Review to fill that gap.
Why invest in direct real estate?
Competitive 9.2%+ returns, low volatility, strong income, diversification benefits, and protection from inflation. But beware of lack of liquidity and complexity.
Updated January 30, 2018 BY IAN IPPOLITO
Update: January 30, 2018: Residential real estate wallops stock market in groundbreaking new study. Un-leveraged residential real estate outperforms stocks over the long term, and with much less risk and volatility. Data-driven investors may want to adopt a tectonic shift in strategy.
One of its secrets is using a diversified portfolio to reduce risk. And a big portion of that portfolio (16% in 2015) was allocated to direct, private real estate.
Before explaining why, I should clarify what I mean when I say "direct, private real estate". Direct real estate means investing directly in real estate equity or debt (...rather than indirectly holding it through a vehicle on the public stock market like a REIT. See "Why not a REIT?"). Until recently, only the largest institutions could afford to invest in it, because of the incredible cost of maintaining a properly diversified portfolio. But with the invention of real estate crowdfunding, that's changed.
Here's its advantages:
Competitive 9.2%+ returns...
A 2015 paper by Cornerstone Advisors, found that " real estate offers a unique blend of recurring income and long-term capital appreciation potential. Returns have averaged 9.2% annually for large core real estate holdings over the past 37 years."
Core real estate is investing in only the most stable and conservative properties. Returns on more speculative real estate strategies involve more risk, but can be higher.
Core real estate is many times less volatile than the stock market. Here's the up and down roller coaster of the stock market over the last several years:
And here's the much calmer volatility of direct core real estate:
The other thing that's obvious from the charts is that the cycle of core real estate is much longer than the stock market cycle. This can give investors more time to notice changes and react.
... with low volatility.
And it's not just less volatile compared to the stock market. Here's a chart from MetLife, showing how core, private real estate has been one of the lowest volatility investments over the last 20 years. (And at the same time the highest yielding). Note: the NPI/NFI-ODCE indexes track the performance of core, private real estate.
And here's a comparison that goes back all the way to 1934. Core real estate suffered one fifth the number of negative years of stocks and bonds.
Real estate, like any other asset, can generate return by increasing in value. But unlike many other assets, it also often generates income (from renters). This double-barreled return generator, not only boosts profits, but contributes to the lower volatility. (Even if the stock market is down, renters still have to pay landlords the same rent.)
Russell Investments institutional arm, wrote in a paper: "real estate is an important addition to multi-asset portfolio.…[because of] strong income return… It has evolved… to a mainstay investment in institutional portfolios."
Adding uncorrelated assets to your portfolio (investments that don't rise and fall at the same time as your other investments), is a proven way to increase your overall returns. A MetLife report measured the correlation of stocks, bonds and direct, private real estate. It found that "Since 1990, the average 5-year rolling total return correlation between core real estate and large capitalization stocks and that of US government bonds was 0.56 and 0.67, respectively." it concludes: "Its low correlation relative to other asset classes boosts its weighting within a modern portfolio. Core real estate is a portfolio diversifier over a long-term hold period."
Protection from inflation.
Many types of real estate provide rental income, and these tend to rise over time along with the CPI (Consumer Price Index), which is used to measure inflation. Per the previously mentioned Russell Investments report "Core private real estate's long-term relationship with inflation has been more favorable than that of either equities are bonds.… This ability to perform well in rising interest rate environments makes core private real estate and attractive alternative for income oriented institutional investors"
But what about the downsides?
No discussion of direct real estate would be complete without discussing it's drawbacks. It's definitely not for everyone, and even if it is, it's not suited for your entire portfolio. (See "How Much Real Estate Is Ideal for My Portfolio").
Here are the downsides:
Liquidity is the ability to cash out of your investment. With a stock or bond, you can cash out. With real estate you can't do that. You might be committed for a year, multiple years, or even indefinitely long (like depending on when a property is sold at a particular price). So if an emergency happens and you need the money, you may be completely out of luck. Real estate investing is not for short-term money, or money you might need anytime soon.
Less frequent valuations
How much is your investment worth? With a stock or bond, you can login online and see the value instantly. With real estate, your property might not be appraised for months, a year, or longer, depending on the terms of the investment. This can make gauging its actual value difficult.
Much more complicated
In my opinion, this is the biggest downside. The legal and operating structures behind every direct real estate investment are overwhelmingly complicated to a new investor. A typical PPM (Private Placement Memorandum) runs at least 30 to 50 pages of dense legalese. That doesn't even include analysis of the capital structure, and pro forma documents, and all the other due diligence documents, which take considerable time to read and understand.
If you just blindly rush in, you can end up making an expensive mistake that you regret for years. So direct real estate investors have to be willing to make the time and effort to educate themselves, then other types of investors, and be willing to commit significantly more time into due diligence while considering each investment.
This goes hand-in-hand with the complexity of real estate investments. These investments can go bad due to numerous problems with the individual investment, or larger issues with the local community, larger community, or even the macroeconomic environment for that particular class of real estate. As such, there are considerably more factors for an investor to consider in a real estate investment, versus other investments.