Many investors who own income-producing investment properties may wonder why their traditional stock and bond portfolios also have an allocation to real estate. It’s not unusual for financial advisors to recommend that clients should own publicly traded real estate securities like REITs or real estate mutual funds and ETFs for added diversification benefits.
When Correlation Collides
Due to the low correlation between real estate and publicly traded stocks and bonds, we believe there is a compelling case to support the idea there is value in holding both public and private real estate. As a reminder, correlation is a statistic that measures how two securities move in relation to each other.
For example, stocks and bonds typically have a low correlation which is why advisors construct client portfolios with each. When stocks are underperforming due to economic or market conditions, bonds often provide portfolio balance and help reduce overall volatility. But it doesn’t always work that way. Just consider 2022.
Investors are still stinging from the market losses dished out last year. For one of the rare times in history, stocks and bonds declined at the same time ending the year underwater, with the S&P 500 off 19.4% and bonds, represented by the Bloomberg U.S. Aggregate Bond Index, down more than 12%.1 It’s been estimated retirees lost 23% of their savings in 401(k) retirement accounts in 2022.2
Diversification - Now More Than Ever
Investors won’t readily forget this “no place to hide” anomaly, which is why many investors and their advisors will look to further diversify their portfolios from the potential impact of another severe market drawdown. And real estate is an asset class that will draw increasing attention.
Public or Private - Or Both
Recognizing that real estate can be an effective addition to an investor’s portfolio, it’s important to look at the differences between public and private real estate options.
As mentioned, public real estate investments are readily available to investors in the form of REITs and real estate funds. These securities are considered liquid, allowing investors to trade in and out of positions as the market conditions dictate. And public real estate ETFs offer the added advantage of relatively low costs.
On the other hand, publicly traded real estate securities can be influenced at times by the same broad market conditions as stocks, causing them to perform in a more correlated manner and limiting their ability to help reduce portfolio volatility.
Private real estate, which can be accessed through direct ownership or a variety of private real estate funds and other structures, is considered an illiquid asset class where investors’ capital can be locked up for extended periods of time. And investment minimums can be higher with private real estate.
But private real estate isn’t subject to the movements of the publicly-traded markets and subsequently offers an even lower correlation to stocks and bonds than its public counterparts. Also, private investments can be a meaningful alternative source of income and an effective inflation hedge as well.
As with any investment, investors should consider the risks associated with public REITs and private real estate investments. Public real estate securities risks include market, interest rate, and concentration risks. Private real estate risks include illiquidity and market, regulatory and credit risks. Carefully assess the risks when considering either of these asset classes.
Let’s Have a Conversation
If you’d like to discuss how your private real estate investments align with the public real estate securities you likely hold in your investment portfolio, schedule an appointment with us here for a no-obligation assessment of these critically important holdings.