As sophisticated investors already know, including alternative investments in a portfolio helps protect against volatility and downside risk while providing an opportunity to achieve
It should then come as no surprise that real estate is among the most popular alternatives since, unlike strategies such as managed futures or derivatives contracts, real estate is tangible. Think office buildings, apartment houses, shopping centers or undeveloped land, among other possibilities. And as Mark Twain reportedly said, “Buy land. They’re not making it anymore.”
Many investors take that quip to heart, but don’t necessarily want to be property-owning landlords. Since most people are already familiar with mutual fund investing, a REIT, which looks very similar, might seem like the best solution. Certainly, the asset class has gotten off to a strong, though likely unsustainable, start this year. But with a total return of -4.12 percent for U.S.-based REITs in 2018, they are also coming off their worst year since the financial crisis over a decade ago.
The REIT market has grown considerably in recent years—the National Association of Real Estate Investment Trusts estimates the total equity market cap of the asset class as $1.1 trillion—and that’s not necessarily a good thing for investors. As the size of the asset level has grown, REITs have become much more closely correlated to the overall equity market, thus reducing how much diversification they can bring to a portfolio.
For accredited investors, an often-overlooked alternative to REITs or private real estate funds is direct real estate investing. It’s something that institutional investors have used for years to complement and mitigate the risk from other assets in their portfolios. Historically, it’s been difficult for individuals to find or get in on direct real estate deals, but there do seem to be more opportunities these days.
One of the primary advantages that direct investing has over a REIT or private real estate fund is that investors get to choose specifically which projects they want to be part of. In a real estate fund, particularly a publicly-traded one, there’s an inherent lack of transparency and investors won’t be able to tell what properties are in their portfolio.
A direct real estate investment is about investing in a specific building or development project. Investors know where they are putting their money and specifically what they own. They understand the risks involved and know who the partners they’ve invested alongside of are. Those are the types of things that work together to inspire investor confidence.
On the other hand, with a real estate mutual fund, shares are sold and investor money is gathered and then the managers go out and look for properties to purchase, which means there can be a gap between when the funds are committed and when they are actually put to work. In the haste to deploy the capital before the fund must start paying dividends, managers may not always find the right property mix and investors can end up exposed to a mix of both good and bad deals.
We also shouldn’t overlook the emotional and psychological benefits that can come to high-net-worth individuals from direct investing. They can fund projects in towns and cities where they live or that they know well. They can drive past the project site and see how it’s progressing. And in the case of something like a hotel or multi-family development, they can walk through and see the finished product.
That benefit also ties in with another growing trend among investors—impact investing. Direct real estate investing can help revitalize communities and dramatically improve the quality of life in some of our older cities. Not only does this allow investors to use their money to create something for the common good right before their own eyes, but they also stand to reap a competitive financial return by doing so.
When taking everything into consideration, it’s easy to see why direct real estate investing for high-net-worth investors can offer benefits beyond those afforded by REITs and other similar funds, especially for those who wish to avoid the hassles that come along with being a landlord or property manager.
Jeff Sica serves as president, CEO and CIO of Circle Squared Alternative Investments LLC, an SEC-registered investment management for firm. This article is for informational purposes only and should not be construed as an offer or solicitation. Investing in alternative investments is subject to risk, including the potential loss of principal.
