Commonly referred to as the “fourth asset class” – after stocks, bonds and cash - real estate is a distinct investment category that can play an important role in a properly diversified investment portfolio.
Investment real estate does not include your home. That is a good thing because the average annual inflation-adjusted return on residential real estate is close to zero over the past eighty years.
Investment real estate displays investment characteristics of both a stock and a bond. Net rental income generated from the real estate can produce a stable income return and any future appreciation of the value of the real estate can add a total return dimension to the investment.
For most investors, a real estate investment trust is the best way to invest in real estate. A REIT is akin to a mutual fund that owns rent-producing real estate. It allows for a small dollar investment in real estate with professional property management and geographic diversification. A unique risk to a REIT over direct ownership of investment real estate is stock market risk - the market value of the REIT stock can separate from the underlying value of the real estate.
Owning individual investment real property and assuming the role of landlord is a higher risk-reward proposition. While the use of fixed-rate mortgage debt in a rising real estate market can generate substantial returns for the owner, likewise a falling real estate market could have a seriously adverse financial impact. A major disadvantage to direct real estate ownership is the notion of “tenants, toilets and trash” – managing real estate can be a full time and frustrating job, especially for busy professionals.
