Real estate is usually held as part of a larger portfolio, and is generally considered an alternative investment class. Real estate fits well as part of a portfolio because it has several qualities that can enhance the return of a larger portfolio, or reduce portfolio risk at the same level of return. Some of the benefits of having real estate in your portfolio are as follows:
Diversification Value – The positive aspects of diversifying your portfolio in terms of asset allocation are well documented. Real estate returns have relatively low correlations with other asset classes, which adds to the diversification of your portfolio.
Yield Enhancement – As part of a portfolio, real estate allows you to achieve higher returns for a given level of portfolio risk. Similarly, by adding real estate to a portfolio you could maintain your portfolio returns while decreasing risk.
Inflation Hedge – Real estate returns are directly linked to the rents that are received from tenants. Some leases contain provisions for rent increases to be indexed to inflation. In other cases, rental rates are increased whenever a lease term expires and the tenant is renewed. Either way, real estate income tends to increase faster in inflationary environments, allowing an investor to maintain its real returns.
Ability to Influence Performance – In previous chapters we’ve noted that real estate is a tangible asset. As a result, an investor can do things to a property to increase its value or improve its performance. Examples of such activities include: replacing a leaky roof, improving the exterior and re-tenanting the building with higher quality tenants. An investor has a greater degree of control over the performance of a real estate investment than other types of investments.
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