I believe that real estate provides the best risk-adjusted returns of all asset classes. However it is not real estate investing, but rather stocks that dominate water cooler talk and media coverage. While some the "investability" of real estate has changed recently with the proliferation of REITs and crowdfunding, I find my non-real estate friends and colleagues still being fixated on, and investing almost entirely in, stocks. In this post I attempt to bring an evidence-based argument for investing in real estate.
Volatility: Real Estate wins
There is a fascinating academic paper called "The Rate of Return on Everything, 1870-2015" from which I pulled the two charts below.
The volatility of stocks versus residential real estate is on full display here. I'd say 140 years makes for a compellingly large dataset.
There's another way to depict this, which is the Sharpe Ratio. All you need to know about the Sharpe Ratio is that it indicates risk-adjusted returns. Investing in Uncle Tommy's new pizza restaurant is going to have a lower Sharpe Ratio than investing in a stabilized real estate deal with an experienced sponsorship team. The higher the ratio on an investment, the better the risk-adjusted returns are on it.
A picture is worth a thousand words, indeed.
Here's another chart that is specific to the US and analyzes just the period from 1993-2013. This is from Thomson Reuters and the US Treasury and cited in this article. "NPI" is the National Property Index, representing core real estate assets.
It seems like a no-brainer, so why is it that in most cases, people put their investments into stocks and bonds over real estate?
The Rules
For the average American, the easiest way to invest in anything is through a 401k with their employer. When's the last time you saw a real estate private offering in your 401k? That's right, it simply isn't an option. So we take what we're given, which are stocks and bonds.
A Little Bit of Work
Before you invest in anything you should research it, including stocks, bonds and mutual funds, which are simply collections of stocks and/or bonds. I suspect little of that actually happens because familiarity breeds complacency. However if you were to be approached with a real estate opportunity, you need to do your research on the lead partners, the market, submarket and the deal itself. It's by no means an extreme amount of work but you do have to do some research and analysis. In fact, the SEC requires that all investors in private offerings are either accredited or sophisticated.
Real Estate is Illiquid
You can't easily buy and sell real estate like you can stocks and bonds which are almost as liquid as cash. This is good and bad for real estate. Remember the top chart showing how real estate is much less volatile than stocks? Well this is why. Since it takes time and effort to buy and sell real estate, it is less prone to sudden swings, whereas Elon Musk tweets something crazy and it instantaneously sends Tesla stock soaring or careening off a cliff. Real estate is a tremendous wealth builder but it is the antithesis of day trading or making/losing 5% in a day. It rewards patience above all. In fact it is not wise to invest money into a real estate deal if there's a high likelihood of your needing to withdraw that money before the business plan is completed.
What Now?
If you have liquid funds available to invest via cash savings or a qualified retirement plan such as a Solo 401k or self-directed IRA, reach out to us at info@BlackRiverEP.com to learn whether investing in multifamily is right for you.
Chihiro Kurokawa is founder of BlackRiver Equity Partners, a real estate private equity firm providing private offerings to investors seeking tax-advantaged cash flowing investments in real estate.
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