Why You Should Stop Calling Real Estate An Alternative Investment

May 4

Author: Jared Feldman - Wednesday, May 4, 2022

Whether planning for retirement or seeking to grow net worth, traditional financial advice advocates for building an investment portfolio around two asset classes: stocks and bonds. Any asset that is not a stock or bond—like real estate—tends to be referred to somewhat dismissively as an alternative investment. My team and I believe that this is shortsighted.

In the following article, I lay out a thesis for why real estate is no longer an alternative investment. In fact, I believe that, in today’s economy, it is very much a mainstream asset class that deserves an allocation as part of a diversified portfolio of risk assets.

The JOBS Act Of 2011

In April 2012, President Barack Obama signed the Jumpstart Our Business Startups (JOBS) Act into law. The principal aim of the legislation was to encourage funding of small businesses by easing some of the regulations associated with the issuance and sale of securities.

Specifically, certain provisions of the bill provided issuers with exemptions from securities registration requirements as long as certain conditions were met. In addition, the JOBS act removed a ban on the solicitation of security offerings, which allowed companies to reach a bigger audience of potential investors without geographic restrictions.

For commercial real estate assets, the passage of the JOBS Act marked a major turning point in their status as an alternative investment because it opened the door to the possibility of crowdfunding equity from individual investors.

The Rise Of Crowdfunding

In light of the JOBS Act, the potential benefits of crowdfunding quickly became clear. For real estate investment firms, it opened the door to new sources of capital. For investors, it opened the door to the types of previously unattainable, institutional-quality real estate investment opportunities that make for an attractive addition to the traditional stock/bond portfolio. In response, new businesses and business models were created to capitalize on these opportunities.

As it relates specifically to real estate, firms like Crowdstreet (founded March 2013) and Yieldstreet (founded January 2015) created platforms designed to match real estate firms with individual investors looking for commercial real estate investment opportunities. In addition, private equity firms—like mine—bypassed these platforms altogether to work directly with accredited investors.

Either way, the result for investors was access to a new world of private real estate investment opportunities designed to provide consistent returns through passive income and price appreciation. Given their novelty at the time, it is understandable that these types of investments would be considered alternative. But, nearly 10 years later, this term is out of date. The ubiquitous nature of private commercial real estate investment opportunities and the strong returns associated with them have taken this product out of the alternative space and placed it at the forefront of mainstream investing for three reasons.

Reason Two: Passive Income

In the typical private real estate investment structure, the transaction sponsor does all of the hard work to find, finance and manage the investment property. For individual investors, this means that partnering with a sponsor on a transaction provides a stream of passive income without the hassle of having to manage the property.

Reason One: Diversification

Commercial real estate price movements tend to be inversely correlated with those of stocks and bonds. In other words, when stock/bond prices fall, real estate prices may rise or even stay flat. This relationship means that adding real estate to a stock/bond portfolio further diversifies risk, which is a positive for investors.

Private real estate investments can be further diversified by location, property type and investment sponsor to provide another layer of safety for investors. As a general rule of thumb, more diversification is better and private real estate investment provides plenty of opportunities for it.

Reason Three: Tax Benefits

Current tax laws allow real estate investors to deduct certain expenses associated with an investment in commercial real estate, which can lower their overall tax liability. Additionally, investors can defer capital gains taxes on the profitable sale of a property as long as they reinvest the proceeds into another “replacement property” that is “like kind.” Further, this process, known as a 1031 Exchange, can be repeated indefinitely, which allows an investor’s capital to grow tax-deferred.

Private Real Estate Goes Mainstream

Passage of the JOBS act, combined with the investment benefits described above, has caused a surge of capital to flow into commercial real estate. Among those most responsible for popularizing the idea that real estate deserves some level of portfolio allocation are university endowments. Cadre reports that “the standout endowments of Yale, Princeton, and Harvard notably posted annual returns of 10.3%, besting a traditional 60/40 equity/bond portfolio by a substantial six percentage points annually. A meaningful portion of the strong returns generated by Ivy League endowments appears to stem from their sizable allocations to real estate.”

But, university endowments aren’t the only participants that have invested substantial amounts of capital into private real estate. On the heels of the JOBS act, Crowdstreet reports $2 billion invested in over 488 deals since its founding, with nearly all capital coming from individual accredited investors. Likewise, Yieldstreet reports $1.9 billion invested from nearly 300,000 individual members.

The important point is this, there was a time when limited access and high capital requirements may have qualified real estate as an alternative investment that was not suitable for all portfolios. But, the passage of the JOBS Act served to democratize individual access to private real estate deals and capital has flowed in. Because private real estate offers investors the chance for additional portfolio diversification, passive income and reduced tax liability, it is far from an alternative asset class in 2022. In fact, blessed by university endowments, private equity firms and hundreds of thousands of accredited investors, private real estate is now fully mainstream and deserves a place in the portfolio of all investors who want it.

The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.

This story was originally featured on Forbes.com

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