We are fast approaching a decade of unsurpassed growth in the stock market indexes, the question being, when does the music stop. By all counts, equity valuations are quite high, perhaps fueled by the low interest rates, and the backing of the Federal Reserve. At about this time in an economic cycle, with full employment at about 4%, and the inflation at about 2%, it seems that at least three rate hikes have been predicted for 2018. This foreseeably should have somewhat of a dampening effect, and yet almost each day, we reach new highs.
Diversification for the most part, has served as a key ingredient in softening blows brought about by bubbles, and unrestrained euphoria. The common refrain being “where else would I park my money, with bank savings returning paltry amounts of less than 1%. In working with real estate investments over the past few years, I have often found them to be a very viable alternate to the equity markets, especially at times such as these. Investments in actual hard real estate assets are illiquid, susceptible to interest rate fluctuations, and the general vagaries of the economic cycles. However, investments in real estate can come in several forms, some of which I list as considerations.
Real Estate Property
Actual purchase of real estate for investment, or for rental, can be considered where current financing makes it attractive. An analysis of the Internal Rate of Return based on the location of the property, the cash flow, and tax issues such as passive losses, the terms of financing etc. would need to be determined prior to the purchase of the property. The attractiveness of these assets as investments are further noted by the use of the like kind exchange provisions of the tax code, which allow for deferment of taxable gains. The downside of holding real estate is the illiquidity, and the cost of carrying the property where the local market or the economy start to show signs of weakness.
Real Estate Syndications
A substantial amount of real estate is held by individuals as passive investments in Limited Liability Companies and Partnerships, where the managing members or the general partners, take on the role of the purchase of the property, the operations, and the eventual sale of the property. These provide individuals and entities with the opportunity to participate in real estate investments without the burden of being involved in the managing of the property, which is done by the managing members, or the general partners for a management fee and a percentage of the profit on the eventual sale. This form of passive investment has its merits such as convenience, although it is highly dependent on the management skills of its syndicators.
Real Estate Investment Trusts
Commonly referred to as REITS, these are companies that have been introduced since 1960, where they hold commercial real estate such as shopping centers, malls, hospitals, hotels, office and residential apartments. REITS are set up as income generators as they are required by their structural set up to pay out 90% of their income by way of dividends to avoid taxability. Another major advantage of REITS is that that some of the REITS are listed on publicly traded exchanges which make them a valuable investment to hold if liquidity is of concern to the investor. The diversification of the type of REITS that are available also is a major consideration as to the ownership of these type of instruments, especially where income needs are a requisite of the investor.
In conclusion, investments in real estate provide an alternate to investments in equity markets, although they are highly capital intensive and financing becomes key, due to cash flow dependency. Usually they do not serve as investments to be considered for short term purposes, given the risks associated, but where there is due diligence and a careful analysis undertaken at the time of the investment being made, they can be very productive for both income and capital appreciation.