By Dr. James M. Dahle, WCI Founder
I often get asked why I bother investing in private real estate syndications, funds, or REITs (or allow companies offering these investments to advertise at The White Coat Investor) instead of just investing in the Vanguard REIT Index Fund. Today, I'll explain.
However, before we get to the question being asked, we need to address a few other issues. First, let's make the case for investing in real estate at all.
Why Invest in Real Estate?
Why do I invest in real estate at all? Three very simple reasons:
- High returns
- Low correlation with the other major components of my portfolio (stocks and bonds)
- Relatively resistant to inflation (like every component of my portfolio)
That's it. That's why I do it. I don't do it for the cash flow (I still practice medicine and get paid by WCI). I don't do it so I have a “hard asset” that I can drive by and check on. It's purely a financial decision. I believe having real estate in my portfolio improves the risk-adjusted returns of the portfolio.
Why Overweight Real Estate?
An indexing purist would point out that the publicly traded stock market already includes lots of real estate. Every company owns buildings and land. A total stock market index fund contains more than 150 real estate investment trusts. Real estate is one of the 11 sectors in the stock market—it's worth well over a trillion dollars and equal to about 3% of the stock market. Isn't that enough? Why would you want MORE than that?
I overweight real estate in my portfolio (my portfolio is 60% stocks, 20% bonds, and 20% real estate) because the vast majority of real estate is NOT publicly traded. There is something like $70 trillion in real estate in the United States, about half of that in residential real estate. So 98% or so of real estate is private real estate. That's a massive part of our economy, so “overweighting” real estate is just making up for the fact that most real estate is privately held.
The same thing happens with other sectors of the economy but not nearly to the same extent. There are only a few thousand publicly traded companies in the US and 27 million private ones, but 21 million of those private ones don't even have an employee. Still, 86% of firms with 500 or more employees are privately held. However, when you look at profits, more than 80% of company profits come from publicly traded companies. That's just very different from real estate. So it makes sense to overweight real estate despite the fact that there is real estate in your index funds.
The Case for Direct Ownership of Real Estate
When I look at how people structure real estate investments, I see it as a continuum.
On the left side, you have direct ownership. On the right side, you have a publicly traded REIT mutual fund. There are benefits to both sides of this spectrum and to everything in between. The main benefit to operating on the left side of the spectrum is control. The main downsides? Hassle and risk.
The case for direct ownership is as follows:
- Maximal ability to add value to the investment through your own efforts
- Maximal control over taxation
- You get to keep all the profit; you don't have to pay any to a manager
- You could potentially use depreciation to offset ordinary income if you (or your spouse) can qualify as a real estate professional
However, most of the people asking me why I bother with private real estate are not talking about direct ownership, even through a turnkey company. They're talking about private syndications, funds, and REITs. These are the passive ways to invest in real estate, just like investments in publicly traded REITs are passive investments. These people have no interest in finding properties, choosing tenants, dealing with Airbnb/Vrbo, or upgrading a home before flipping it. They have already decided against direct ownership due to hassle and risk issues. They want more diversification and just want to invest their money—not their time.
The Case for Private Real Estate
Private investments are illiquid. They have shorter track records, and they involve a lot of operator/sponsor/manager risk. Fee structures can be complex, and they will seem very high compared to the expense ratios of an index fund. Why would anyone choose to put money into them instead of the solid blue-chip REITs found in the public markets? Here's why I put some (and, in fact, the majority) of my real estate money into private real estate.
#1 Illiquidity Premium
One of the biggest downsides of private real estate investments is their illiquidity. You can trade a publicly traded REIT, ETF, or mutual fund every day the markets are open. Some real estate investments provide no liquidity at all until the property is sold after seven or even 10 years. Even the most liquid investments usually require a one-year commitment and, even after that, only provide liquidity once a quarter (and they may take several weeks to send your money once you do sell). There's only one reason to deal with the hassle of being illiquid, and that's because you are being paid more to do so. That's the illiquidity premium. While everybody needs some liquidity in their lives, very few investors need all of their investments to be liquid. If you could earn an extra 2% or 3% a year for being illiquid, how much of your portfolio would you allow to be illiquid? Probably quite a bit.
#2 Lower Correlation with Stocks
Publicly traded REITs are traded publicly on the stock market. Sometimes the stock market goes down for a reason that has little or nothing to do with real estate performance, and this can also affect the REITS traded on the market. Certainly it affects them more than it affects private real estate. It can be a bit hard to sort out how much lower the correlation is since private real estate is not valued on a minute-to-minute or even a day-to-day basis like the stock market. But it is hard to argue the correlation is not lower at all with a private property.
#3 Depreciation
REITs also benefit from depreciation like any other property and pass that on to their owners. However, it is not passed on in the same way. Whether owned privately or publicly, a REIT uses depreciation to make more of their distribution a “return of capital” rather than an “ordinary dividend.” That depreciation cannot be used to offset the income from other real estate investments, much less any of your earned income. However, if you are invested in syndications or funds, that depreciation is passed on to you on a K-1 to use however you may qualify to use it.
REITs aren't all bad tax-wise. There's something to be said for getting a 1099 in January rather than a delayed K-1 in June that forces you to file an extension and potentially file multiple state tax returns. REIT dividends also qualify for the 199A deduction. But the inability to benefit from getting the depreciation directly is a downside of public (and private) REIT investing.
#4 Less-Efficient Market
All real estate is local, and it takes a great deal more time and effort to get information about individual privately owned properties than it does to learn about publicly owned companies. The real estate market is simply less efficient than the stock market. That creates both opportunity and risk. A good manager can take advantage of those inefficiencies to create alpha, especially when their competitors in the space are often less sophisticated “mom and pop” investors.
#5 Different (Usually Smaller) Properties
Large publicly traded REITs have a lot of money they need to deploy. So they tend to buy very large properties. Large malls. Large office buildings. Large apartment complexes. That leaves opportunities in smaller properties for private investors. Small properties perform differently than large properties, so private real estate investments allow for diversification into different areas of real estate.
I still invest in publicly traded real estate via the Vanguard REIT Index Fund. It makes up 5% of my total portfolio and 25% of my real estate allocation. But I think there are enough benefits with private real estate to also include it—despite its risks, illiquidity, and hassle.
The Case for Debt Real Estate
My real estate portfolio also includes an allocation to real estate debt (5% of portfolio, 25% of real estate). My preferred vehicle here are private funds that lend money to real estate developers for periods of 6-18 months with loans of less than 75% of value in first lien position. Typical returns in this space are 6%-11% and are quite tax-inefficient since the entire return is paid out every year and is taxable at ordinary income tax rates. That doesn't matter inside retirement accounts but certainly does outside of them. These funds tend to be more liquid than equity funds but do require accredited investor status to invest.
The main risk is that they become equity funds in a downturn when developers decide they would rather give up the property than keep making payments on the loan, but by keeping the Loan-to-Value (LTV) low and having a mechanism in place to manage the properties, this risk can be kept relatively low.
There are also publicly traded REITs that do this, although they are not included in the Vanguard REIT Index Fund (the fund only invests in equity REITs). However, I prefer the privately traded funds/REITs due to their higher yields. They simply earn more. For example, I used to own the Broadmark fund. It went public and immediately went up in value 25% or so, as its yield equilibrated with those of similar companies already being publicly traded. That increase in value, of course, lowers future yields/returns. The risk here is obviously higher than with a treasury bond, but I think I am being paid enough to make up for that additional risk.
What If I'm Wrong?
Every time an investor makes an investment decision, they should consider the probability that they are wrong and the potential consequences. Perhaps I'm wrong about private real estate. Perhaps there is no illiquidity premium or what premium exists is eaten up by fees. Perhaps the correlation with stocks and bonds is not lower than publicly traded real estate—it is just disguised because the properties aren't regularly marked to market. Perhaps the risk of debt real estate is far higher than I believe, reducing the risk-adjusted returns. If this is the case, I will have wasted a lot of time, effort, and hassle. However, based on my experience over the last decade, it seems unlikely that the returns are significantly lower than what I would get in publicly traded real estate.
I hope this post helps you understand why I invest some of my real estate allocation into private real estate and why WCI sells advertising space to private real estate investing companies. If you are interested in learning more about investment opportunities available through real estate companies we work with (most of which I have personally invested with) see the chart below and sign up for our free real estate newsletter. There's no commitment and you can unsubscribe at any time.
WCI’s No Hype Real Estate Investing is the best real estate course on the planet and the best way to get started in this exciting (and profitable) asset class. Taught by Dr. Jim Dahle and more than a dozen other experts, this course is packed with more than 27 hours of content, and it gives potential investors the foundation they need to learn about all the different methods of real estate investing. If you’re interested in real estate investing, you can’t afford to miss the No Hype Real Estate Investing course!
What do you think? Do you invest in real estate? Public, private, or both? How did you decide between the options? Comment below!
Featured Real Estate Partners
I invest in private real estate exclusively through direct ownership at this point. I agree completely with your points and completely highlight the inefficiency of the real estate market compared to say stocks or bond markets. Even with syndications there is more work involved compared to simply buying index funds but well worth it!
Does real estate outperform stock market in the long term i.e 5 -10 years?
First, I wouldn’t call 5-10 years long term.
Second, depends on what 5-10 years.
Third, depends on how much leverage is applied to both.
I compared the two asset classes in this post:
https://www.whitecoatinvestor.com/real-estate-vs-stocks-an-investing-showdown/
Regarding the debt real estate portion; my assumption is that sponsor requires a mezzanine loan (I would think probably around 8% interest) because they were unable to get the full portion through the usual agency loan (around 3%).
I could be wrong, but it makes me think that maybe they are not the best sponsor, or the project is less ideal. Since they don’t have the financials to get buy without a mezzanine loan (why would someone take an 8% loan when 3% is available otherwise with the right project).
So you’re higher in the capital stack; but you’re higher in a seemingly inferior deal/sponsor.
I guess my question is; is the risk-adjusted return worth it for this asset class?
Nearly all of the loans in the funds I invest in are in first position. They’re not mezzanine loans. Why do people take a 10% loan when they could theoretically get a 4% one? Go ahead and try to get multiple 4% loans for 6-12 months quickly and you’ll find out why. It’s just a cost of doing business for a developer. They not only pay 10% or 12%, but they might be paying 2 points too on a 6 month loan. But if it’s a deal that can’t be done otherwise and they’re making $200K on it while only paying $20K in interest…it’s still a good deal for them.
“I believe having real estate in my portfolio improves the risk-adjusted returns of the portfolio.”
-I agree completely with this statement.
As a whole this is very succinct and good explanation for diversification into real estate beyond REITS. Thanks!
To each his own, but these real estate articles always give me a laugh. It’s too risky to buy an individual stock but putting 20% of your assets in syndicated real estate with major risks and leveraging is just fine. Carry on.
If there were a great way to buy all the private real estate like there is with all the public stocks, I’d sure be interested. Until then, if you want access to the asset class, you’re stuck with what’s available. But I do prefer funds to individual syndications for exactly that reason.
I agree. I personally looked into investing on one of WCI’s sponsors. When it came down to it my spouse was actually just too wary of giving $100K plus to one private company who frankly hasn’t been in business for longer than a decade. When you throw in the “we deliver ____% every year like clock work” pitch you start to think what’s the catch. I found myself thinking I should do 100% of my portfolio with them if I can get double digit % every year. Of course I wouldn’t do that. Then I started thinking what if they are just some fantastic Ponzi scheme and 10 years down the line I think I have a million dollars in some account and magically it disappears into the CEO’s crypto cold wallet while he lounges in the Cayman Islands…..LOL
I would add WCI is paid when you invest with these sponsors so there is inherent bias to consider also, similar to a load upfront on a fund.
Bear in mind WCI could get paid for just about any type of “alternative investment” out there, but you’re not hearing about cattle and crypto and colored diamonds and angle investing in my portfolio are you?
Jim has said, I believe several times, that the real estate articles are of great interest to the readers of WCI. I think he says they are by far the most read and most commented articles. That means the WCI community is interested, so he publishes more of them. That probably drives the interest of vendors in buying advertising.
I am not fan of these private deals, far too many unknowns and speculative assumptions required to make them sound like a good idea.
On the other hand, in this piece, Jim has been careful to note that there is little evidence that the assumptions of higher risk adjusted returns and lower correlation with stocks are correct.
Even knowing the returns to private real estate is fraught with problems, as he noted. The appraisal pricing with no regular mark to market means that no one knows what the deals are worth until they try to sell.
As far as I know, the closest there is to systematic data comes from the National Council of Real
Estate Investment Fiduciaries (NCREIF). This is purely voluntary reporting, loaded with survivorship and backward bias. When companies start reporting, they can include their past returns, or not, at their option. Wildly unreliable for that reason. Attempts to correct for these problems lead to little evidence that private real estate outperforms public REITS.
Similarly, efforts to determine whether the private real estate market is efficient come up with equivocal answers. I think the economist answer would be “it may well be. It is hard to tell because the data are so bad.”
For the same reasons, it is unclear what the volatility of these investments may be.
But in this post, Jim acknowledges all of this, perhaps in less detail.
To decide that these deals are worthwhile, one has to come down quite strongly in favor of the low correlation, high expected return, low volatility assumptions, when systematic data do not support these assumptions.
Going for these deals also requires not only that the market is inefficient but that there is some way to identify ex ante those active managers who will deliver good performance. Again, as far as I know, there is no evidence to support whatever approach one might take to do this.
But Jim is not just pitching private real estate. Here, he is noting these issues and telling the audience so that each person can make an informed decision. I find the articles interesting, although I cannot imagine I would ever invest.
Just as he writes good articles about insurance, then lets insurance agents advertise.
Free country. Almost all of us are grownups.
I disagree that going for these deals requires a belief in active management. If you diversify enough, you should get something close to the market return. Now alpha is nice, but it’s not required for my argument. Certainly, it seems easier to generate alpha in a less efficient market though.
So what you’re saying is investments like these would have to provide higher returns because many investors such as yourself are not willing to take on these risks. That sounds like compensated risk to me.
Yes, I am not against private real estate or WCI sponsorships. Totally agree that risk taking should be rewarded with improved rewards as well. My point is that a “small” private company going broke with all my money via fraud or poor management is probably a more realistic outcome than me betting on Amazon, Apple, or Tesla stock and having them go to zero.
That’s probably true, especially if leverage is involved. But it’s a bit of a straw man. I’m not telling you to buy just one just like I don’t tell you to buy just one stock.
How does one find Highly Managed Turnkey property companies or syndication companies that are reputable?
How does one research them?
Well, there’s no Morningstar if that’s what you’re asking. So you have to look at each of them individually. Reading the PPM and other provided materials, talking to management, and getting the real scoop from current investors is usually the method.
Does not the question of compensated vs uncompensated risk arise here too? If that is the case, you shouldn’t reasonably expect greater returns just from going to the left of the spectrum. Yes?
That’s a great question of when a risk becomes uncompensated. The general rule is if it can be diversified away, you are not going to be compensated for it. So you need to own enough properties to diversify away individual property risk. Easier to do that with funds than syndications. And you can diversify management risk by having multiple managers. But there’s no index fund out there that I know of for most of the properties in the country. The big publicly traded REITs aren’t typically buying properties as small as most of those in private funds and syndications.
Interesting! I wonder what it takes to start a ‘Small-Cap REIT Fund’ to cover this gap. Might be hard since slices of our homes and apartments and other real estate properties are not publicly traded.
Is this small property market what everyone was trying to get into by investing in mortgages before ’08?
Wall Street is definitely getting into the SFR market, so maybe this won’t be a reason to be in private real estate a decade from now.
Last year I invested in 3 different syndicated deals on Crowdstreet in early 2021. Each deal was a multifamily value-add project which I feel is the least risky deal since rents are already in place. Each property is in the Southeast and has so far done great. Rents are up 10%+ at each property and ahead of proformas. These deals can be risky if you invest in ground up development, but multifamily value adds seem relatively safe. You have to focus on good locations with a growing population. Don’t invest in a place that is shrinking (New York state for example).
I wouldn’t call value add least risky. There are at least 2 categories less risky than that (and of course ground up is more risky), but they also generally return less. Glad to hear yours are ahead of proforma.
This post reflects a lot of my feelings on passive private real estate investing and why I’m considering it as a small part of my portfolio.
Jim, have you found any advisors willing to evaluate these deals as a paid service? I bet that would be a fairly attractive service to offer.
Regards,
Psy-FI MD
Ha ha, no. But it would be a great value-add wouldn’t it?
This service does exist, I retired early out of finance and spent almost two decades doing lending into these projects. Now I have a few people that I provide deal by deal transaction reviews for. The reviews work best on individual property syndication or early stage funds where the track records are difficult to follow. Once a firm gets into a third or fourth fund, enough institutional investors have done the due diligence on the fund provider to get a fair presentation.
This was a great article overall, I can’t recommend The Hands Off Investor Book enough.
Agree, private real estate placements or real estate syndications are not for everyone. However for many it can improve ones overall portfolio diversity and for many high income professionals has many tax advantages. For me personally (living in a high tax state) , and like WCI, I have chosen to make it roughly a 20% portion of my portfolio and for those interested in financial independence it can certainly abbreviate the time frame when taking into consideration the cash flow many of these investments can give off. What I would say, don’t take our word for it, educate yourself and explore your ultimate goals and financial situation to see where real estate syndications might fit. There are certainly many education materials, websites, and resources these days that are readily available to help with this education process. As I said, for me it has personally helped my portfolio and will continue to invest in these type of deals for the foreseeable future.
The one finite element, for which there is no leverage, mortgage, depreciation, turnkey option, REIT, is time. And I would say that is the one investment that is ultimately being compensated when you are a physician and high-earner: the time you invested and continue to invest in your career.
Real estate investing can be as quick as buying a fund on Vanguard, if you do not do the due diligence. What due diligence means is different for each individual. For a busy academic surgeon with small children, there is very little time to spare to investigate RE deals or search for properties. As other posters said, it requires much more risk tolerance to rely on a syndication than a 100% index fund portfolio. Just look at the data.
As Jim said above, there is some value to being able to do my taxes alone in 4 hours or less. No need to file extensions or wait for K1s. No accountants except turbotax. Any leftover time I can work on a legal review for considerably more money than I make as a surgeon.
I would agree with the preceding comment that for the vast majority of physicians, time spent on medicine and activities directly related to medicine is more likely to be productive than time spent on private real estate. And I would say that the last sentence applies to alternative asset classes in general.
I agree, but note that many WCI readers apparently would rather manage investments than practice medicine. Should have gone to business school instead. Unfortunately, they are stuck. People will pay them to practice medicine but no one will hire them to manage real estate investments.
Some are retired. Others are looking to retire early, spend little or no time practicing but would be willing to devote enough time to running a real estate portfolio to think it would pay off.
David Swensen invested in alternative assets at Yale, and did well with that. But I watched a lecture by him once, and he didn’t make the point that the alternative asset classes that he invested in had higher rates of return. He did make the point that the alternative asset classes Yale invested in had a higher dispersion of return. Just as stocks have a higher dispersion of return than bonds, those alternative asset classes (private equity, hedge funds) have a higher dispersion of return than stocks. And Yale was able to take advantage of those higher rates of dispersion by selecting those who outperform in the alternative asset classes.
I would include private real estate in those alternative asset classes. One can make a good case that especially for smaller properties, private real estate is more inefficient than publicly traded stocks. So for those who possess above average investing skills that are sufficient to overcome the hurdle of increased costs associated with private real estate, it is possible that they can outperform Vanguard’s REIT ETF. But there is an opportunity cost of time in acquiring those skills,, and it is far from guaranteed that even if considerable time is spent, that sufficiently above average skills will be acquired.
I’m sorry WCI, but I’ve never seen good data that private real estate on average offers compelling advantages over publlcly traded assets, when it comes to risk or return. I would agree that for those who are clearly above average, private real estate may increase return and offer tax planning opportunities. But I would make the case that for a full time physician, it is very unlikely that you will be in that category.
I think my comments in the preceding paragraphs apply to alternative asset classes in general.
I don’t invest in alternative asset classes. At least for myself, I think they would detract from the performance of my portfolio.
I have limited resources when it comes to investing. About conventional asset classes, my knowledge is much less than many of those who invest in such asset classes, and with whom to some extent I’m competing. I think that I will get greater return focusing my time and money on conventional asset classes than alternative asset classes. With conventional asset classes, I can spend little effort focusing on security selection, and instead rely on the wisdom of the crowd and indexing strategies to give long term results comparable to those of professional investors. I can’t do that with alternative asset classes. In alternative asset classes, David Swensen needed underperforming investors to achieve his goal of outperformance. If I invested in alternative asset classes, I would most likely end up being one of those underperforming investors.
It is entirely possible that you are right, as I wrote in the last part of the post. But just as you have not seen any good data showing private real estate offers compelling advantages, you have not seen any good data that it does not. And there is a plethora of anecdotal experience among white coat investors that suggests it does.
At any rate, I agree with you that it is not a mandatory asset class required for investment success. Working hard as a doc, carving out 20%+ of gross, and investing it in a handful of boring index funds absolutely does work. There are two questions to ask yourself when it comes to private real estate:
# 1 Is the asset class worth adding to my portfolio?
# 2 Is there a good way for me to add it?
If the answer to either is no, then you should stay away. I obviously answered then both “yes.”
https://www.bogleheads.org/forum/viewtopic.php?f=10&t=273508&p=5410115&hilit=estate#p5410115
In the above link, there is a post by myself regarding real estate. WCI, I beg to differ, when you state that I have not seen any good data that it does not.
There are a lot of links there. Cursory reading suggests most of them don’t directly address the issue at hand. I’ll have to spend some time with those that may.
The first one, from REIT.com, seems to most directly address the question. A bit of a biased source (it’s a publicly traded REIT organization that performed and published the study) and there is also the issue of the timing of the sample. Imagine if the period ended in early 2009 instead of 2017? Publicly traded REITS would look a lot worse.
Second link is the same study as the first.
The third link shows performance is similar with private vs public real estate.
I saw another study while on that page you can find here: https://www.semanticscholar.org/paper/Real-Estate-Investment-Trusts-versus-Direct-Real-A-Mutahi-Othieno/ba1325c324fd07d8e1ac35f42f848fa6b9c95f22
that concluded:
We analyze the risk adjusted performance of Real Estate Investment Trusts (REITs) and Direct Real Estate Investments using US data between 1980 and 2014. As opposed to previous studies where emphasis was placed on Economies of Scale this study employs a multi-constraint portfolio optimization approach based on Mean Variance Optimization and Mean Gini Coefficient Approach. We find that Direct Real Estate Investments outperform REITs without the minimum return constraint.
The fourth link does not address the question.
The fifth link does not address the question.
The sixth link does not address the question.
The seventh link is the same as the sixth.
The eighth link does not address the question.
The ninth link doesn’t work. Your quoted portion suggests it does not directly address the question of public vs private real estate returns.
So basically I find three studies:
1) Public > Private. Bias concerns but definitely concerning
2) Returns are similar
3) Private > Public.
I would conclude the jury is still out from that review. As I said earlier, I don’t see high quality data answering the question.
The 4th link found that real estate doesn’t have unique diversifying properties but does have uncompensated sector risk, with increased uncompensated sector risk in private real estate.
The 5th link found that real estate doesn’t have unique diversifying properties, but does have idiosyncratic sector risk.
The 6th and 7th links found that a stock/bond hybrid produced better general and risk adjusted returns than REITS.
You don’t mention the quotes from “Asset Management” by Andrew Ang at the bottom of the link. Those quotes are consistent with real estate not having unique diversifying properties. They are also consistent with direct real estate not outperforming stock/bond portfolios, and in fact may be worse.
You quote an abstract from an article, but not all of the abstract. The following is all of the abstract:
“We analyze the risk adjusted performance of Real Estate Investment Trusts (REITs) and
Direct Real Estate Investments using US data between 1980 and 2014. As opposed to
previous studies where emphasis was placed on Economies of Scale this study employs a
multi-constraint portfolio optimization approach based on Mean Variance Optimization
and Mean Gini Coefficient Approach. We find that Direct Real Estate Investments
outperform REITs without the minimum return constraint. When we incorporate the
minimum return constraint REITs out-perform Direct Real Estate Investments both for
annual and monthly returns. These results can be attributed to the high risk-return
characteristic of REITs.”
The part of the abstract you quote is in favor of “Direct Real Estate Investments” over REITS. But you’ve omitted the following sentence, where the authors came to the opposite conclusion, when the authors incorporate “minimum return constraints”.
From the end of the paper in the Conclusions section:
“It shows that Optimal Portfolios containing REITs offer superior returns as evidenced by
the table 11 below.
The portfolios containing REITs were found to outperform those containing Direct Real
Investments mainly due to two factors; a) the higher risk associated with REITs, thus the
higher return exhibited by them and b) Direct Real Estate investments’ return being a
function of timing the real estate cycle”
One can download the paper from the link below:
https://ideas.repec.org/a/spt/fininv/v4y2015i4f4_4_5.html
Links 4-7 are arguments against real estate in general, not arguing for public over private, which is the issue we’re discussing here.
I don’t put “minimum return constraints” on my portfolio so I don’t care what kind of statistical wizardry they did there. The returns were higher for private.
I don’t pretend to understand all the statistics in this paper, but from the discussion:
From the results in Table 3 and 5, we see that Optimal Portfolios under both approaches
have higher weightings of Direct Real Estate Investments as opposed to REITs and that
the optimal portfolios containing REITs are outperformed by those containing Direct Real
Estate Investments.
This could be attributed to the fact that REITs are more volatile investments as opposed to
Direct Real Estate Investments as evidenced during the recent Global Financial Crisis
when REITs were seen to have dropped by around 60% at one point in time during the
worst of the crisis as opposed to the NCREIF Index when returns in comparison only
dropped by about 15%. Considering that, the study was centered on minimizing
deviations; our optimal portfolios would therefore have higher weightings of Direct Real
Estate Investments as compared to REITs.
It sure sounds like the paper says private real estate was the winner in their sample to me. It’s pretty darn hard to compare apples to apples with that chart in the conclusion. I mean, they’re comparing one portfolio that is 90/7/3 to one that is 50/2/49 to one that is 34/31/36 to one that is 23/33/38.
Just hold everything else constant and use either REITs or private real estate if you really want to answer the question. And since the private real estate outperformed, those portfolios with the private real estate would beat the ones with the public REITs.
I think that paper is still in favor of private.
From the discussion of that paper:
“The findings above are similar to those of [24] and [25]. The two studies found that over the past thirty years, portfolios containing REITs have been able to outperform those containing Direct Real Estate Investments by about 4% annually. These results are also similar to those of [14] where they found that portfolios containing REITs continue to outperform those containing Direct Real Estate Investments on a long term and recurring basis”
Do I conclude that I’m missing much by not investing in private real estate? No.
[24] Harvey, J. (2010). The Truth about Real Estate Allocations. New York: Cohen & Steers.
[25] Hughes, F. (2006). Property Stocks Outperforming Direct Real Estate on All Fronts. Brussels: European Public Real Estate Allocation
[14] Cohen & Steers. (2013). Revising the Truth about Real Estate Allocation. New York: Cohen & Steers Inc.
I don’t understand much of this paper. But sorry, the returns weren’t higher for private. See Table 1 on p.67.
Mean return of REITS was 13.54, and for Direct Real Estate Investment was 8.46. Now the volatility of the former was greater; the respective standard deviations were 17.35 and 7.62.
That’s after they apply some statistical wizardry about “minimum returns” that apparently reverses the actual returns.
It’s interesting that all the papers (none of which I’ve read) were all published prior to the JOBS Act. I wonder how that has impacted things.
Park.
Those are great references, thanks.
One of them cites a paper that used data not from the private and public real estate industries, but from pension funds. Those funds reported their returns from public and private real estate investing. Public was better.
A series of anecdotes do not make for data.
Hearing someone say how well they have done in private RE, without providing, or likely even knowing, the volatility and risk adjusted returns, is meaningless. Same as if one were to conclude that investing in individual stocks or active mutual funds based on hearing some people say they did well doing it.
“There are two questions to ask yourself when it comes to private real estate:
# 1 Is the asset class worth adding to my portfolio?
# 2 Is there a good way for me to add it?
If the answer to either is no, then you should stay away. I obviously answered then both “yes.””
Those are two good questions. The following from a financial advisor (not myself):
“that any strategy (or product) recommended to a client should have a clear link to how the recommendation furthers the client toward his/her stated goal – AND how the client is unlikely to achieve the goal in the absence of such a strategy/product.”
Both these questions can be applied to private real estate.
Higher returns and lower correlation with the rest of the portfolio pretty clearly further the client toward their stated goal.
Not sure I agree with the second part. For example, one could easily hit FI using actively managed mutual funds. That’s not a reason not to use an index fund.
I agree with so much of this article.
I was a semi-successful operations executive in Pharma for most of my career and my wife was also in the medical arena. We both had very busy careers. The final seven years of my Pharma career, I branched my personal passive index investing into private (direct-ownership) rental property investments. In some part, to diversify and to have more control, but mostly to lay the groundwork for a strategy to retire early. Fifty-plus rental units (directly-owned) later, we both retired at 50 years old. It’s been 98% passive, as I have utilized a local property management company for day-to-day operations, while still working and raising a family. We continue to utilize that same management company now that we are fully retired. Returns over the last 12 years from that RE portfolio have averaged +12% (yes, partially leveraged…but conservatively). Now five years early retired, and utilizing that RE portfolio exclusively for retirement income, and allowing my passive index investments to continue to grow. RE depreciation continues to shelter nearly 50% of our retirement income, keeping taxes low and enabling us to Roth convert tax deferred passive investments. It’s been a great strategy for us. Our portfolio is now at 42% REI, 8% Cash, 25% Stock Indexes, 25% Bond Indexes. Sleeping well at night and enjoying the start of our sixth year of retirement.
Some commenters say it’s too complicated or risky investing directly in RE. I’d argue, if a simple country boy can implement this strategy, with no mentor, while working a busy operational Pharma career… It can’t be but so risky or difficult. Those who don’t think they can’t do it because it’s too complicated or takes too much time, are right. You’ve already convinced yourselves, so stay in passive indexes.
WCI, cheers to your strategy, and another great post on REI!
I agree that there can be tax advantages with real estate, and you mention RE depreciation. OTOH, a greater proportion of total return in real estate is from income (rents, dividends) than cap gains, in comparison to stocks. Everyone’s tax situations differs, but income is commonly taxed more than cap gains. You also mention that your real estate is levered; that will help with taxes, but one can apply the same strategy to stocks.
Asset Management by Andrew Ang, p. 428.
“Tradeable and cheap index funds in bond and stock markets allow investors to separate systematic returns from management prowess. In illiquid markets, no such separation is possible; investing in illiquid markets is always a bet on management talent. The agency issues in illiquid asset markets are first order problems…Agency problems can, and often do, overwhelm any advantages that an illiquidity risk premium may bring.”
I would modify my preceding posts, but since I can’t, I create new posts. I think the above quote is relevant to alternative assets. And I note the preceding comments about compensated vs. uncompensated risk.
Hello All,
You have to understand the true value of incorporating real estate syndication into a portfolio is not just to increase returns. Even though it has been alluded to the true value of real estate investing has to be looked at in total. It is no accident that many of the wealthiest individuals of our time are real estate investors. Therefore the above discussion which compares returns using either traditional index fund/stock market investing versus alternative investing is not necessarily appreciating the full point of investing in such assets. The main difference is when you invest in alternative such as real estate syndication you are more focused on cash flow as opposed to accumulation which is what you’re doing over a career investing in index funds. I will try to clarify:
1. Accumulation vs Cashflow approach to FI
Admittedly there is some cash flow associated with equities best thing in the form of dividends but this is somewhat minimal. However in real estate syndication although pass performance does not indicate future performance on average you can expect somewhere in the range of a 7% cash on cash return. Therefore when investing $1 million you can achieve on average $70,000 annual return from real estate syndication that doesn’t deplete your original $1 million. In the classical 4% rule investing in index funds you would be able to draw down on average $40,000 per million saved so for somebody to achieve $200,000 annual income with this method they would need to save 5 million which is a significant sum over a career but not unachievable. However with real estate syndication, when you reinvest what you have eraned and continue to invest the path to FI timeframe can be shortened if that is your goal.
2. Tax treatment of Income:
The second significant reason to consider alternative investing is the way they are treated from attack standpoint in that often you can use depreciation to fully offset any passive income during most of the deal excluding a capital event at the time of sale. That’s income obtained from these alternatives can often be a net tax free income if you continue to invest in assets that offer depreciation an ongoing basis you can offset future income from these deals. Conversely when drawing down equities or stock market investing either dividend or other they count as taxable income and is treated as such thus requiring a higher drawdown amount to achieve the same net income.
Like WC I said to each his own in this world and you could achieve your goals with either path, however it is just important to have an honest and informed discussion as the pros and cons of each and value in such. But as you can see there is more than just comparing the returns of each technique, and why myself and WCI choose to incorporate it in our portfolio.
cont.
3. True Diversification:
It’s fair to say that we all would like to achieve a portfolio that can withstand changes in the markets with differing economic cycles. Although I still contribute a fair amount to my equity portfolio what I can say is my REIT positions within my equity portfolio in March 2020 went down just as much as the rest of my portfolio whereas my alternative or syndication investments they did not and continued to cashflow. One doesn’t have to look much further than that in our recent memory as a time to really see if you have a diversified portfolio. In the end this last point cannot be understated as nobody knows when the unpredictable winds that guide our stock market will once again change.
No, I don’t buy the income argument as I’ve written many times previous. Assets and income are interchangeable and income is often far less tax efficient. If I want more income, I can always swap at that point into whatever provides more income or start selling shares. Whatever you think is some optimal income investment, I can just sell whatever I have and buy. Same, same.
I agree you should look at after-tax returns though. There are tax advantages for stocks just as there are for real estate. For example, once the depreciation is gone, rents are taxed at ordinary income. Meanwhile, an index fund rarely distributes capital gains and dividends are all long-term. Plus it’s far easier to donate to charity.
Your point is well-taken but isn’t there something to be said for having regular, reliable income that doesn’t bank on your selling assets that can fluctuate, sometimes wildly, from year to year? Who feels good about selling assets when they’re down just to sustain their lifestyle? I do get that over the long term it should all even out but psychologically I think having the steady cash flow is easier to live with not to mention it can make certain decisions easier, e.g. cutting back your practice.
I understand your argument. Let’s say you want an asset where you won’t have to sell assets to spend income. Perhaps a rental property. You can sell your mutual fund shares and buy it and voila! You no longer have to sell shares. Likewise, if you’re sick of getting income, you can take the income producing asset, sell it, and buy an asset that does not produce income. They’re interchangeable.
More on the Pros and Cons of Income Investing here:
https://www.whitecoatinvestor.com/the-pros-and-cons-of-income-investing/
Bonds generate cash flow with no need to sell. So do annuities. So do stocks. Nothing special about real estate.
For me, the biggest pitch for real estate is that some forms of ownership come with tax advantages. Given all the other problems with it, I would not invest. If I were on the fence, I would try to calculate after tax risk adjusted returns vs a stock and bond portfolio or a stock bond and REIT portfolio.
https://www.institutionalinvestor.com/article/b1t8kyrtdkbfkc/In-an-Apples-to-Apples-Comparison-Public-Real-Estate-Investments-Outperform-Private-Ones
“In a new study published in the Journal of Portfolio Management’s real estate issue, authors Thomas Arnold, David Ling, and Andy Naranjo found that, when compared side-by-side, real estate investment trusts outperformed U.S. closed-end private equity real estate, or PERE, funds by 165 basis points annually.”
https://academic.oup.com/qje/article/134/3/1225/5435538
“The annual data on total returns for equity, housing, bonds, and bills cover 16 advanced economies from 1870 to 2015…
In terms of total returns, residential real estate and equities have shown very similar and high real total gains, on average about 7% a year. Housing outperformed equities before World War II. Since World War II, equities have outperformed housing on average but had much higher volatility and higher synchronicity with the business cycle…we find that long-run capital gains on housing are relatively low, around 1% a year in real terms, and considerably lower than capital gains in the stock market. However, the rental yield component is typically considerably higher and more stable than the dividend yield of equities so that total returns are of comparable magnitude”
p. 610 of “Asset Management’ by Andrew Ang
“Bond and MItchell (2010) show a conspicuous lack of alpha, on average, for managers in the other major illiquid asset class, real estate.”
The 2nd link doesn’t address the question (you can stop posting those BTW).
The the third citation doesn’t include a link to the Bond and Mitchell study, but from your quote, it doesn’t address the question.
The first link, however, is very interesting. I couldn’t get any more than the abstract though. I can’t even tell what time period they looked at. But it was just published a few months ago and appears to directly address the question at hand. I’d be interested in reading the article (and perhaps even writing it up for the blog) if anyone has access to it.
Bond and Mitchell link
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1550850
“This paper investigates whether fund managers investing in the direct real estate market can systematically and persistently deliver superior risk-adjusted returns. The research that has been published has typically focused on the performance of managers trading public real estate securities…The widespread finding is that very few managers appear to be able to generate excess risk-adjusted returns. Furthermore, there is little evidence of performance persistence in either fund returns or risk-adjusted fund returns.”
As mentioned, the difference in this paper is that they examined managers who were directly investing in real estate, as opposed to investing in REITs. Very few of these professionals investing in private real estate were able to generate excess risk-adjusted returns.
Yea, but the question they’re addressing is whether they can generate alpha or not, not private vs public. That’s not what we’re looking at.
Park-
You may be interested in the study referenced in this article too:
https://www.investmentexecutive.com/in-depth_/partner-reports/4-quadrant-approach-to-real-estate-investing/
It suggests lower returns for private but that a mix of 30% public and 70% private provides the best combination of returns to volatility.
The chart in this one is also interesting. While the article is about active management, if you look at the chart it shows higher returns for private vs public.
https://www.investmentexecutive.com/in-depth_/partner-reports/there-is-a-substitute-for-direct-real-estate-investment/
Interestingly on the active management subject, the most recent SPIVA scorecard shows active real estate funds outperforming at the 3 and 5 year marks (although behind as you would expect at the 10 and 20 year) marks. Not sure what to make of that, but it is unique among stock asset classes.
https://www.spglobal.com/spdji/en/documents/spiva/spiva-us-mid-year-2021.pdf
Not particularly interested in the active/passive debate here, but very interested in the private/public debate. I’ve got someone sending me those articles from JPM.
It is fascinating that after all these posts and comments about private real estate, this is the first time I have seen proponents attempt to present data in favor of it.
It does make me wonder, yet again where all the excitement came from. Apparently not from careful studies.
Most of us could easily explain and cite data in favor of index funds. Odd to have no data until now in support of something in which many people apparently place large portions of their net worth.
I might consider when there are data supporting it comparable to those for index funds.
Until then, it is more magic of active investing.
There certainly isn’t good data. I just went through the most recent paper on the topic and just reading what they had to do to get any data to analyze at all was pretty eye opening. I don’t have much faith in it.
If you’re interested, the paper concluded that on average private funds underperformed public REITs but that the median private fund outperformed public REITs. Kind of a mixed bag. It would be nice to be able to prove that private real estate provided an illiquidity bonus as theory says it should, but I haven’t found the data yet. I wonder what it might look like in a period of time when stocks did poorly but real estate didn’t necessarily (a la 2008). I would guess that private would have a greater advantage in times like those.
I would be interested in the illiquidity premium if it existed. You cannot generate a premium by making a basket of the same investments illiquid. You could create an illiquid fund, gated exit, long lockup, etc. It would be quite illiquid. If that fund put everything in VTI, your expected return would be that of VTI, minus fees. No magic illiquidity premium.
To the extent that one can invest in RE in liquid form, that may eliminate the premium for buying it in illiquid form. If there is any premium at all then it may all be captured by those with direct ownership. As soon as one starts paying fees on top, what little premium there might have been might go to the layers of management, leaving nothing to the investor.
Note that these studies of the returns to private real estate that avoid the data problems concern large investors. Pensions and endowments can own directly and manage their own portfolios. They have to pay employees to do it, but less than if they were in these consumer-level funds. One would have to subtract some amount from return expectations derived from these large investors to account for the higher costs of these funds and syndications.
If someone were doing pure direct ownership and managing the real estate themselves, then they could sort of use the experience of endowments and pension funds as a guide. But they are still in a different segment of the RE market than individuals.
For those who are wealthy enough to replicate what the pensions and endowments do- invest in large, prime, commercial properties, manage them internally and do their own financing, then they might realize a liquidity premium if it exists.
I doubt one could do this with a net worth of $40M, investing, say $20M in private RE.
I suspect it starts to become possible when one is able to run a RE portfolio of $50M, which requires a much higher networth unless one was prepared to have everything they own in private real estate.
I just do not see the argument, or the data, for syndications or private funds.
If there was an illiquidity premium, it would make sense to take private real estate public. There are sophisticated investors ( hedge funds) who would do that. Admittedly, such investors would be limited to larger forms of real estate. But I’m not aware of this happening.
One reason may be that the illiquidity premium is too small to justify the effort required to take private real estate public. If so, you should watch costs carefully, as they might negate any illiquidity premium.
The illiquidity premium is commonly used as a reason for private investing in general, and not just private real estate. The preceding paragraphs are relevant to private investing in general.
One way to get any illiquidity premium might be to focus on smaller properties, where going public is less feasible. This is analogous to investing in small cap/microcap stocks. ButI’ve traded such stock. The increased costs of trading such stocks is not small. And your security selection skills are more of an issue; there’s less ability to ride on the coattails of the marketplace, when it comes to pricing. What I’ve written about small cap/microcap stocks may be relevant to small real estate properties
I’ve only had one private real estate investment go public (Broadmark). There was a large liquidity premium as its price went up dramatically (and yield dropped) in the month or two after it went public (then I sold it), then basically started tracking with the other publicly traded debt funds.
That’s anecdote, not data, but it certainly doesn’t refute the idea of an illiquidity premium.
Read another paper today: Reexamining the Real Estate Quadrants by Kieran Farrelly and Alex Moss
which argues for a blend (like I do) of your real estate between public and private. The public had higher returns and the private had lower volatility in a sample from 1997-2020. They gave figures of 9.8% for a 50/50 blend on the equity side and 9.2% for a 100% private. A portfolio of 25/25/25/25 (public/private equity/debt) was 8.0%.
Incidentally, all of these papers seem to be looking at the same database. It appears to be the only one there is that any research at all can be done with.
You’re assuming fees and costs in the private world are by necessity significantly larger than in the public world. I don’t know that that is true. Those running public entities also like getting paid.
I’m not sure a fund with $250K minimums is truly a “consumer-level” fund. We’re only talking about a few dozen investors in many of them.
My whole point of private real estate IS NOT the big huge properties. It’s the smaller ones that the public REITs don’t bother investing in. Same with value-add or even opportunistic strategies. The big boys just do core strategies.
I think the argument is easy to make. The data…not so much. What there is is very low quality but what we have isn’t showing a huge return advantage for private.
Of course, some real estate is public. That is what REITs are. But I agree that one might expect to see much more activity in creating new REITs and taking them public if that were a profitable undertaking.
Some of it may be cost.
Some of it may be that RE investing is just not that fabulously profitable. The field does seem to let a few individuals make big profits but that does not mean there would be anything left over for small investors. It does not mean that the well known successes are typical.
If someone wants to run a RE investing business, managing properties and financing themselves then they should expect it to return what that business returns. Likely a wide range of reasonable expectations with a substantial risk of failure, like other small businesses. Strange to see docs wanting to do this. If it were profitable enough to be a more lucrative use of their time than practicing medicine, then the field should be filled with lawyers, accountants MBAs and other people who are comparably well educated but have lower hourly returns in their day jobs.
I would rather work as a doctor than as a real estate manager. I would need to make a lot more money on the latter to even consider switching.
It is mainly the enthusiasm from people who have no data to back up their assumptions that baffles me.
For now, I just chalk it up to wishful thinking
It’s not that hard to make more in real estate than doctoring. Lots of docs only make $150-250K. After-tax, $2-4 million in unleveraged property is likely earning more than that.
I’m not convinced about private real estate’s role in a physician’s portfolio. If a physician has skills in real estate that are sufficiently above average to overcome cost headwinds, it’s reasonable to consider. But when I say average, I mean the average dollar weighted real estate investor. Real estate investing will tend to be dominated by a fewer larger investors, who are more knowledgeable than the average investor. There would be few physicians who would better than the average dollar weighted real estate investor.
The argument is made that that with smaller properties, there may be more opportunity. But as mentioned elsewhere, that mentions you either own or are a coowner of a small business. I doubt that small businesses devoted to real estate do better than small businesses in other sectors of the economy. Real estate is just one sector of the economy. Why would private investment in one sector of the economy be more productive than private investment in the other sectors of the economy? I’m not aware of data that investment in small businesses is more productive. Indeed, in publicly traded stocks, whether a small cap premium exists is uncertain.
About costs, I’d suggest reading David Swensen’s book that he wrote for retail investors. He liked public REITs, but private REITs were another story, and the difference in his opinion was mainly due to costs.
I would consider public real estate an optional part of a physician’s portfolio. I haven’t seen data that real estate can’t be explained by factor models. When one has more public real estate in your portfolio than in the market as a whole, you’re taking on uncompensated sector risk.
Some of the most profitable companies in the world are small businesses. Far easier to grow a $1M business by 200% in a year than a $200 billion business. That’s not a reason to avoid small properties. Small cap stocks are far from small businesses. A microcap business is a $50-300 million company.
I’m familiar with Swensen’s book. I’m also aware of his audience and the REITs available to a typical investor when he wrote it.
Most real estate is private real estate. If you’re just taking the public market cap, you are underweighted in real estate compared to the economy.
I do agree it’s optional. No called strikes.
“Most real estate is private real estate. If you’re just taking the public market cap, you are underweighted in real estate compared to the economy.”
One could make the case that many investors are overweight in real estate – especially private real estate – and need to diversify away from it. That’s because they’re homeowners.
When I say it is uncertain whether the small cap premium exists in publicly traded stocks, I’m also saying that it is uncertain whether the small cap/microcap/nanocap premium exists in publicly traded stocks.
And I agree that the growth potential of a small business is much greater than a larger business. But I’ve seen the data for publicly traded stocks. As market cap decreases, median return decreases. Positive returns are increasingly dominated by a comparatively small group of stocks that do much better than average. However, as market cap decreases, average return may or may not increase. If you have above average security selection skills, then this is an opportunity for you. But if not, then the average returns are relevant to you. Based on the security selection skills of physicians, I suspect that the average returns are relevant to the vast majority.
Is this information on publicly traded stocks applicable to real estate? I very strongly suspect that it is applicable to public real estate, as they are publicly traded stocks. I also think it likely that it is applicable to private real estate. If one postulates that private real estate is different in this characteristic, one has to give a reason why private real estate would be different than public real estate.
About most real estate being private real estate and if you have the public market cap you’re underweight in real estate compared to the economy, I’d like to make the following comment. If I invest in public real estate, I can make a bet solely on the systemic returns of public real estate. But it’s not possible to make such a bet in private real estate. If I invest in private real estate, I’m making two bets. I’m betting on the systemic returns of private real estate and I’m also making a bet on active management. In publicly traded stocks, I can make a bet on active management if I want. But I don’t have to and I chose not to. I’ll lose my bet on active management in publicly traded stocks. Why would the outcome of a bet on active management in private real estate be different? Since I think one of my two bets in private real estate would be a losing bet, I’m not going to bet on private real estate.
It’s not a bet on active management if you buy enough of it. You can get “closet index fund” returns.
Which brings us back to the question of why one would want a closet index fund of private real estate. With a REIT index fund, you are not paying anyone to pick the underlying investments
With a large portfolio of private real estate, as Park says, you have no choice but to pay for active management. The expected return would be that of an index minus the higher fees. One could do the same thing with stocks, buy a large sample of actively managed funds to get something similar to the index . But again, you pay those fees
I have previously asked: If one wanted exposure to private businesses, why pick RE?
What about bowling alleys?
Nail salons?
Restaurants?
Hundreds of other kinds of small businesses?
What is special about RE?
You’re not understanding what I’m saying by “closet index fund.” It’s a reference to how you can get a market return when there are no index funds available for an asset class. You can’t buy a private real estate index fund, but you can still get the market return by buying enough funds. Yes, there are additional expenses if they are active managers.
I don’t know much about bowling alleys or nail salons. Restaurants have been shown to be terrible investments. If there is something you understand better than real estate, then sure, go invest in that.
As has been previously discussed, private real estate is one category of private investing. There’s another category of private investing that is used and which has been researched. That is private equity. I’ve never seen research that found it was to the retail investor’s advantage to invest in private equity, as opposed to public equity. There are those who do well with private equity – David Swensen is an example – but such people are far from being your average retail investor. One could make the case that the relationship between private and public real estate is different than that between private and public equity. OTOH, I think one could make a case that the relationships are similar; both are comparing publicly traded assets versus nonpublicly traded assets.
Personally, I prefer publicly traded assets. With such assets, a comparatively unsophisticated investor -such as myself- can take advantage of the greater knowledge of sophisticated investors. With privately traded assets, sophisticated investors can take advantage of me.
Hey Park and Afan-
I get it. You two don’t want to invest in private real estate. That’s fine. You don’t have to each post two comments to this thread every day for the rest of your lives to let us know.
How does the expense ratio of the “closet index fund” strategy of private real estate compare to Vanguard’s REIT index fund?
Remember that the compensation of the CEO and other staff of the publicly traded REITs doesn’t show up in the mutual fund ER. Apples and oranges.
I get the pount about a closet index fund being better than picking one active fund. Buy the market of active funds and expect the market return, minus fees. One would only do this if there were no way to avoid the fees and the active management.
In the case of real estate, it is possible to avoid one layer of active management by going with a REIT index funds. The underlying REITs are businesses with management expenses, just as for any other stocks. But you don’t pay someone to pick the REITs for you.
I don’t know anything about bowling alleys or nail salons either. I just don’t see why RE, specifically, is picked as a proxy for all private businesses. In restaurants there are many opportunities for franchise operations. Some people have many such places, not necessarily all from the same parent company.
Just another private business.
Insurance brokers.
Plumbers
Construction contractors
Pest control…
Long list.
What is so special about RE compared to these and hundreds of other businesses?
Thanks for the article, Jim!
My question is how do you assess value of your entire private real estate allocation in order to keep it within the 20% band you have selected? Do you base the value on your capital invested or do you try to do some calculation of your income received divided by market cap rate? I have started to dabble in private real estate with some investments in a couple multi family syndications. As it is the start of the year and I need to reallocate my equity/bond holdings, I’m trying to get different opinions on how people assign value to these real estate investments. Obviously, it’s pretty easy to know the value of your REIT funds, but the private real estate seems a hard one to know the exact value. Maybe that’s the point! 🙂
Some companies provide an ongoing value/NAV. For those that do not, I leave it at the amount I originally invested until they do. One has been at $20K on my spreadsheet for 5 years even though it will almost surely sell for much less than that. Another is basically fixed at $100K even though it will almost surely sell for significantly more than that. The syndication I manage is revalued once a year, so I change it’s value on my spreadsheet once a year.
That makes a lot of sense. Once the deal sells, you’ll then get another bucket of cash to redeploy in the next deal or mutual fund depending on where your asset allocation needs it.