As of the fourth quarter of 2020, 65.8% of households in the United States own their homes1. This implies that a majority of Americans are already familiar with owning real estate as part of their overall portfolio. With that being said, many people are less informed about how to invest in real estate outside of their primary residence. Believe it or not, there are a variety of different ways to include real estate as part of a diversified portfolio, and not all of them require you to have tons of money saved up to invest. This article will highlight some of the ways investors are using real estate to generate passive income and reduce some of the negative impacts inflation can have on their portfolios.
Real Estate Investments Trusts (also known as REITs)
A real estate investment trust is a company (or trust) that is formed to use investors’ money to buy, operate, and sell income-producing properties. Shopping malls, office buildings, warehouses, and apartment buildings are all examples of properties that REITs may consider. Many REITs trade on major exchanges, similar to stocks and exchange-traded funds (ETFs), which makes them more accessible to many investors as well as more liquid compared to other types of real estate investments. Also, a REIT must pay out 90% of its taxable profits in the form of dividends to shareholders. This allows the entity to avoid paying corporate income tax on those profits and in theory, pass on more of the returns to its shareholders.
Real Estate Investment Groups
Real estate investment groups are typically partnerships or corporations that focus the majority of their efforts on investing in real estate, but either do not choose to or do not qualify for being a real estate investment trust as described earlier2. For example, a company will buy a set of apartment buildings then allow investors to buy them through the company. The company that operates the investment group manages all the units and takes care of things like maintenance and finding tenants. For these services, the company takes a percentage of the monthly rent. Although these fees can sometimes be quite high, the pooling of investor’s resources often allows for multiple investments to hopefully diversify and maximize profits.
“House Hacking”
Okay, so this one might be related to your own home, but it is becoming a popular way to earn money from real estate that some people may not be too familiar with. House Hacking is a term coined by podcast host Brandon Turner used to describe buying a home with a rentable room or separate unit in order to help pay the mortgage or earn passive income.3 House Hacking can include buying a multi-family unit to live in one unit and rent out the others, or even renting out the shed in the backyard by converting it to a living space. These types of strategies can allow people to generate income from their properties to help reduce other expenses like car payments, insurance, and property maintenance costs.
Benefits of Investing in Real Estate
- Diversification: Real estate historically has a low correlation with other major asset classes which can help diversify your investments as well as lower overall portfolio volatility. From January 2011 - December 2020, REITs actually had a negative correlation with Cash and Currencies and a low 0.38 correlation with Investment Grade Bonds.4
- Inflation Hedging: As the economy grows, the demand for real estate usually increases as well. And since real estate is a physical asset, property values tend to rise during times when the prices of other goods and services are increasing (aka rising inflation).
- Cash Flow: Investments like rental properties and other real estate investments can provide a steady flow of monthly or quarterly income. One of the goals of real estate investing is to make this cash flow as passive as possible so the investor can focus on other areas of their life, you know, the parts that are actually fun…
Diversification, inflation hedging, and cash flow generation are just a few of the benefits associated with investing in real estate, but an investor should still consider the potential drawbacks before deciding to include real estate in their portfolios. These include less liquidity than many other investments, ongoing expenses, and potential tenant challenges / vacancies to name a few. As always, it is best to consult with your financial professional to help determine if investing in real estate is right for you.
1. https://www.pewresearch.org/fact-tank/2021/03/08/amid-a-pandemic-and-a-recession-americans-go-on-a-near-record-homebuying-spree/
2. https://www.investopedia.com/terms/r/reig.asp
3. https://www.forbes.com/sites/davidgreene/2018/12/04/house-hacking-how-financially-savvy-people-live-in-expensive-markets-while-saving-money/?sh=687dc8470f06
4. https://www.guggenheiminvestments.com/mutual-funds/resources/interactive-tools/asset-class-correlation-map