by Don Wenner, As published by Forbes
Given today’s ever-changing market, diversified investment portfolios are more important than ever in achieving maximum returns and minimizing overall risk. To hedge their bets, many investors are looking beyond well-diversified stock and bond portfolios to alternative investment vehicles, such as real estate.
Many real estate investors put their cash directly into properties they buy, renovate and either manage as rentals or flip for sale. However, the alternative in this asset class that requires much less physical work and presents a far greater reward potential is passive real estate investing.
It may not sound as glamorous as flipping for a quick return, but as the founder of a real estate investing group, I know it to be a true portfolio workhorse. Passive real estate investments, especially those focused on multifamily housing, do the lion’s share of heavy lifting to generate high returns and hedge against volatility.
Diversifying With Real Estate
At its best, diversification goes beyond stocks, bonds and cash equivalents to more effectively buffer against volatility. Real estate is a natural counterweight to those investments.
Some may question that premise after the 2008-09 recession when the housing bubble burst at the same time as stocks dramatically fell, but there is a key difference between then and now. Today, we are experiencing an unprecedented undersupply of housing, a condition that only increases real estate’s value and potential power as a passive income source. Other experts agree, noting this undersupply makes it unlikely that stock market volatility will lead to lower housing prices or that real estate will cause the next economic downturn.
Also, unlike stocks, real estate is a tangible, physical asset that serves an ongoing purpose. Real estate investments provide portfolio stability in large part because society will always need physical facilities in which to live and work.
Passive Real Estate Investing: The Advantages Over Its Active Counterpart
To many, real estate investing means flipping houses or owning a portfolio of properties, both endeavors that require significant know-how, money and time, and is often accompanied by unrealistic expectations fueled by the “celebrity” nature of the industry. Even renting residential or commercial properties owned requires significant work, from marketing and lease creation to property maintenance and management, and it often comes with slim margins and major headaches. It’s rarely a truly “inactive” undertaking.
The alternative is investing in private real estate funds, which offer a true passive pursuit. Such funds are available to the general public through firms like ours and various others. Like mutual funds, after an investor researches available options with their financial advisor and opens an account, the private real estate fund does all the work, compounding over time to exponentially increase holdings with little to no investor effort.
Even though investors never have to lift a finger, someone does. That falls to the manager of the funds, who is responsible for asset management, property management, construction management and capital management. Therefore, it is critical to choose a proven manager with the knowledge, skills, team and resources to execute on all aspects of strategy and management. Like any great investment, it comes down to having a good strategy and great execution.
Multifamily Outperforms Other Real Estate
Of the various real estate segments, multifamily housing is one of the most attractive for investors. Unlike single-family housing, whose management can be too inefficient to create economies of scale, or commercial properties, which often entail complex, incomprehensible variables, multifamily housing is at once scalable and comprehensible for investors. And, CBRE research revealed that multifamily rents declined less during the 2001 recession and were more resilient during the 2008-09 recession.
Workforce Housing Works Hardest Of All
Within multifamily housing, the hands-down unsung workhorse is workforce housing, defined as housing “that can be reasonably afforded by a moderate to middle income, critical workforce and located in acceptable proximity to workforce centers.” This is due to a confluence of factors, including:
• Rising home prices: More people, particularly with median and lower incomes, are looking for affordable housing.
• Sluggish wage growth: Many millennials strapped with debt and facing stagnated wages can’t afford to move out of their parents’ homes, and when they do, workforce housing is their most realistic option.
• Other financial priorities: CBRE found that even higher-income-earners are often prioritizing other financial goals, such as paying off student loans or saving for retirement, over luxury living.
• Undersupply of workforce housing: Throughout the recovery from the 2008-09 recession, new multifamily development has focused largely on Class A units, not Class B or C. Further exacerbating this undersupply, large swaths of the latter have been torn down to make way for higher-end development.
• Recession demand: When the next downturn occurs, demand for workforce housing will only increase as people are pushed out of homeownership or Class A units.
• Higher cap rate: Buyers can generally acquire these properties at a higher return rate.
The Biggest Bang And Buffer For The Investment Buck
Passive real estate investing, especially in multifamily workforce housing, yields high returns without volatility. Simply put, workforce housing outperforms high-end multifamily. Affordable, well-situated and well-managed units appeal to the most renters and offer the biggest and least labor-intensive return potential for real estate investors. Appealing attributes include:
• Renovated properties: Everyone wants an attractive and inviting place to live.
• Convenient locations: Renters want to live near expanding employment opportunities, good public transit and highways, quality schools and safe neighborhoods.
• Second- and third-tier cities: Rising prices in first-tier cities are driving workers to less-expensive areas that offer opportunity and affordable apartment living.
There is more here than attractive returns. When the economy finally takes a sustained downward turn, investors will want a buffer against stock market losses. The dramatic undersupply of workforce housing compared to its demand will largely and naturally limit portfolio volatility while continuing to offer a passive income stream for investors. It is both bang and buffer for the investment buck.