Why Institutional-Grade Private Real Estate Investments Must Be Your Focus
Buying real estate, to the average investor, typically means one of three things:
- your own primary home
- a rental property
- a small tenement or apartment building
For most of modern human history, only the mega-rich were able to deal in commercial real estate on a mass scale.
But that changed.
The advent of real estate syndications meant that institutional-grade deals were no longer only for institutions and multi-millionaire families. The question now is: do you really understand the leverage, potential, and security involved in such deals so that you will definitively take advantage of them?
We believe that, to truly be a successful passive investor in our current world, you must devote a sizeable portion of your capital to institutional private equity real estate.
And we’ll explore the reasons below.
Low Volatility Supports Stable Income
Real property, by its very nature, tends to be much less volatile than stocks. It is less liquid after all.
Then when you look at the economies of scale involved in commercial real estate (eg. multifamily housing like a 100+ unit apartment complex), the process becomes much more efficient, safe, and profitable.
The net operating income (NOI) on commercial real estate has remained remarkably stable year after year.
That dependable cash flow, even across troubling times, can make a large difference not just on your wallet but also on your peace of mind.
Which brings us to overall returns.
High Risk-Adjusted Returns
If we simply look at total return numbers, then stocks and REITs are usually higher than real estate. Especially in the short term… if you can magically time the market.
However, as mentioned above, returns only tell part of the story, and need to be compared to risk (volatility).
This is where the Sharpe Ratio comes in.
We can measure risk-adjusted performance of any given investment. In short, we take the annualized rate of return for a portfolio and then subtract an annualized risk-free rate (from a 3-month Treasury Bill). Then we divide that result by the annualized standard deviation of the portfolio returns.
Check out the numbers on this 20-year comparison of investments* using the Sharpe Ratio (Jan 2000 – Dec 2019):
- Stocks: Total Return 6.06%, Standard Deviation 15.79%, Sharpe Ratio 0.27
- REITs: Total Return 11.18%, Standard Deviation 20.85%, Sharpe Ratio 0.45
- Bonds: Total Return 5.03%, Standard Deviation 3.42%, Sharpe Ratio 0.95
- Institutional Real Estate: Total Return 8.73%, Standard Deviation 4.55%, Sharpe Ratio 1.51
* Data: Morningstar Direct from 01/01/2000-12/31/2019 — Stocks: S&P 500 | Bonds: Bloomberg Barclays U.S. Aggregate Bond Index | REITs: MSCI U.S. REIT Index | Institutional Private Equity Real Estate total return from the National Council of Real Estate Investment Fiduciaries Property Index (NPI)
You get the safety of bonds but with much more compelling returns.
Combining cash flow and appreciation benefits in a comparatively low-risk investment is about the best you can hope for.
But we can add some other interesting quirks of institutional private equity real estate that make it even more attractive.
Tax Advantages Of Commercial Real Estate
The old saying goes “it ain’t how much you make, it’s how much you keep”.
Private real estate offers tax benefits that are nearly unfair. And you should take advantage of them!
In the US, real estate can have accelerated depreciation. And investors can then deduct that as an expense from their real estate income to reduce their tax burden.
There is also the option to do a 1031 Exchange. This means you can take your capital gains from a real estate investment, re-invest them into another property, and defer the taxes owed. If you continue doing this until the end of your life, you can leave the ownership of the current property to your family and eliminate any capital gains owing.
So just these two tax benefits turn a compelling investment into a legacy-building one.
* * *
In summary, you may not have a ton of experience with institutional private equity real estate. Perhaps you even feel strangely about it, since it has been historically reserved for an elite group of investors.
But you must not discount it as a vehicle for incredible wealth generation in a very conservative and passive way.
You have access, via syndications, and should avail yourself of it.
The trick, of course, is to find a trustworthy syndicator, with an expansive network, who can vet the deals for you.
And these investment opportunities should not simply be on your radar. They should be your primary focus.