Building a portfolio of rental properties has become a very popular investment approach and is often treated as a retirement vehicle.
The development and/or management of properties can provide healthy returns and rents can generate a strong income stream. These income streams do not tend to have the same volatility as the stock market and often produce higher returns than bonds.
However, there are downsides to consider when exploring real estate as an investment strategy. Expenses such as taxes, maintenance, property management, insurance, legal expenses for evictions, tax reporting and vacancies are some of the more obvious costs that impact total return to the investor. For many, liability, worry and the time commitment were not so obvious when they began to build a portfolio of properties.
Without a proper management structure and a broader allocation to other asset classes, real estate investments often become a burden rather than a benefit.
There are alternative methods to real assets that do not require the same challenges as the traditional real estate purchase and management. Real assets are a separate and distinct asset class from traditional financial assets where the value is generated through contracts or claims to real or intangible assets.
Real assets are generally allocated to three broad categories: real estate, infrastructure and natural resources. Investments in these areas can provide stability to portfolios due to the relatively low correlation with financial assets like stocks and bonds. Real assets have a tendency to outperform financial assets during inflationary periods and also have generally held up well in bear markets. There are obviously exceptions to that statement, some of which are still pretty fresh for investors in some markets.
1. Real estate is one of the more popular real asset categories and investment exposure can be accomplished in many different structures beyond individual property ownership, such as real estate investment trusts, REIT exchange traded funds, agricultural land pools and globally diversified real estate funds. The diversification benefits of both direct and indirect real estate investments are well known, and investment options are plentiful.
It is important to find the investment vehicle that provides the necessary benefits to your overall portfolio to reduce volatility and make that investment in a structure that matches up with your time commitment.
2. Infrastructure is gaining in popularity and finding its way into many institutional portfolios and, to a lesser extent, private ones, as well.
According to a 2017 Brookfield report, infrastructure has the lowest global allocation of real asset equities, but it is now competing with real estate and is often closely linked. The report showed the global value of real asset equities totaled $5.6 trillion, with 57 percent comprising natural resources, compared with 23 percent in real estate and 20 percent in infrastructure. What makes infrastructure appealing for many investors is the stable cash flows. Infrastructure investments include transportation, power plants, sewage treatment projects, water supply, telecommunications, networking equipment, education, prison, defense and health care facilities.
3. The natural resource category includes things that are mined or collected in raw form, including agriculture, oil and precious metals. Natural resource investment options include direct investment, futures, options, exchange-traded funds, bonds and stocks. Often, these investments are used as a direct hedge – for example, as a hedge against a crop – but demand may be driven by political buying, global infrastructure and repair, store of value buying and by the ultimate consumers. When the natural resources themselves are too volatile for a portfolio, investors can invest in the underlying industries that generate the commodity, such as gold mining, oil drilling, agricultural equipment manufacturers and suppliers.
While real assets may be appropriate for inclusion in a diversified portfolio beyond stocks, bonds and cash, proper asset allocation is critical to establish a suitable risk profile. Recommended allocations to these asset classes vary significantly depending on the time frame, state of the markets and methods of investments. Rates of return goals, risk tolerances, hedge strategies and time horizons drive the appropriate allocations to these asset classes.
In practice, allocation decisions can become complex and are the biggest driver for the overall performance of an investment portfolio. Professional guidance is recommended and a well thought out financial plan is the best place to start.
Tim Parrish is president of Missouri Trust & Investment Co. He can be reached at firstname.lastname@example.org.
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