Andrew Sinclair is CEO and Principal of Midloch Investment Partners, a real estate investment fund manager and operator based in Chicago.
Most Americans own stock, also known as equities, in publicly traded companies. More precisely, says Gallup, 62% of American adults own stocks directly, through mutual funds or in their retirement accounts. Bonds, which are debt securities issued by government entities and corporations, is another common asset class. Cash and cash equivalents are frequently held, too.
It makes sense for Americans to invest in equities because the stock market is highly liquid; you can buy or sell shares virtually anytime. Plus, the stock market’s track record is pretty good. Since the late 1920s, the average annual return is about 10%.
Other types of investments—often known as “alternative investments”—are held by fewer people. Generally, this is because alternative investments are less liquid (thus more difficult to trade) and because they are less easily compared to other investments on an apples-to-apples basis. Think of selling a second home versus selling a painting that has appreciated in value.
In some ways, real estate investments are the least alternative of “alternative investments” because investment properties can generate income, like stocks can pay dividends. Real estate can also appreciate over time, like how stock prices may rise. Income-producing investment properties are all around us: warehouses, apartment buildings, shopping centers, office buildings and all sorts of other special-use facilities that Americans frequent every day.
How Private Real Estate Differs From Stocks
At the same time, private real estate differs from stocks in a couple of notable ways. For one thing, the value of private real estate assets doesn’t typically rise and fall in tandem with the stock market. In other words, their performance is not correlated. In this way, real estate represents diversification from stocks and has the potential to do well when the stock market is flat or even down.
Real estate’s performance is a function of many factors, including supply and demand, location, demographics, macro and microeconomic growth, the quality of the investment and asset management teams, and the business plan for the asset or portfolio.
At my company, a commercial real estate operator and investment fund manager, I’ve seen private real estate become increasingly appealing to high-net-worth investors, family offices and registered investment advisors, especially to those investors with patient capital who recognize that real estate is a long-lived asset class. Patient capital allows for an income property’s business plan to be implemented and realized in order to maximize the investment opportunity for income and appreciation over time. In other words, patient capital isn’t necessarily looking to get in and out of investments quickly, or, in the case of the stock market, panic sell when stocks go down.
The potential benefits of real estate investing can include:
• Income from the cash flow of investment properties.
• Appreciation from the gain on the sale of investment properties.
• Tax benefits, which may include depreciation and passive losses.
• Diversification relative to stocks and bonds, as well as real estate diversification by property type and geography.
• A hedge against inflation, particularly for property types like multifamily that can increase net operating income through more frequent rent increases as leases roll over. Inflation also tends to increase the cost of capital, which makes new construction of additional supply less attractive.
Considerations For Investors
Many financial planners recommend including alternative investments in your portfolio. There’s no consensus on the right allocation; it comes down to what’s right for you personally. One common recommendation is to have between 25% and 40% of one’s net worth, including their home, be in real estate, while others have suggested up to 50% of a portfolio be in real estate.
Carefully consider your real estate allocation in consultation with your financial and tax advisors, based on your comfort level and willingness to take risks. Private real estate investing, like all investing, offers the opportunity to do well but also has potential for loss, including of invested principal.
To minimize risk, kick the tires on the sponsor or sponsors you invest with by reviewing their complete track record, which may include some losses. Additionally, review the sponsor’s business plan for the specific property or properties to understand how they intend to make money, and consider the timeline for the business plan to be realized, as this may tie your money up for a while. Finally, be prepared for the investment’s tax consequences, including the potential income from cash flow and the potential gain (or loss) at the time of property sales.
I also recommend thinking about multiple ways a property you’re considering might be able to create income for you. My company succeeds by leaning into an investing philosophy that leads us to identify at least two or three ways to make money with every investment before we make an acquisition. It’s no guarantee of success, but so far, the formula has worked out nicely.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
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