Market Volatility Spurs Real Estate Diversification Strategies

How Investors Leverage Commercial Real Estate To Balance Risk and Maximize ROI

History has delivered plenty of epic swings in the stock market with values that can soar or plummet on the heels of a simple news headline or tweet. However, the freefall in late February and early March fueled by fears of a global pandemic was a seismic shift for the record books. The Dow alone lost over 3,000 points in a matter of days. According to one S&P Dow Jones analyst, the market panic wiped out an estimated $6 trillion in wealth. Although the market has clawed back some of those deep losses, it drove home a painful lesson on the critical need to diversify investment portfolios.

Diversification is one of the basic building blocks for any good investment strategy. It checks a number of boxes when it comes to delivering valuable benefits, such as reducing risk, increasing stability, and ideally, creating an overall higher blended return for a portfolio over time. Increasingly, investors are leveraging commercial real estate as a key component to diversify their investment portfolio. Real estate is attractive as a portfolio stabilizer as it is not as susceptible to volatility and knee jerk market reactions. It is also less liquid which creates more stable valuations. In addition, real estate holdings have some inherent advantages over stocks, such as the ability to use leverage (debt) to amplify your returns, generate sizeable passive income, and enjoy benefits related to tax write-offs and depreciation. According to an article on Motley Fool’s Millionaires real estate investing website, the Vanguard Real Estate ETF Total Return has delivered 40% higher returns compared to the S&P 500 Total Return over the last 32 years. That proven track record helps to solidify its standing as a core component of a diversified portfolio strategy.

Although commercial real estate is often lumped into one asset “bucket” so to speak, real estate investments have many different nuances that can shape performance. For example, an office building in Chicago has a different investment profile than investing in a ground up apartment property in Minneapolis or a single-tenant net lease (NNN) CVS in Tampa. Just as an investor would not want to put all of their money into one stock, such as Apple or Tesla, it is wise to diversify real estate holdings.

The benefits of NNN properties

Net lease properties are an increasingly popular way to diversify investment portfolios. In fact, they are attractive across the board among sophisticated institutional investors, investors who are growing real estate portfolios, and individuals who may be making a first step into real estate investing. Net lease investments are commonly viewed as a “bond-like” investment because they are often leased to a single, high-credit tenant such as Walgreens, 7-Eleven, or McDonald’s. The long-term lease, which may be 15 to 20 years or longer, acts much like a corporate bond, delivering steady income to the property owner in the form of a monthly rent check. NNN offers several benefits to investors, chief among them include:

Cash flow: That steady, predictable income stream and steady cash flow is one of the big selling points for investors. The average yield, or cap rate, for net lease asset transactions has been relatively stable over the past five years at about 6.2%. This is quite attractive compared to the lack of favorable fixed income yields in the low interest environment that has persisted over the last several years.

Passive investment: NNN properties are easy for investors to understand. Investors enjoy predictable cash flow based on long-term guaranteed leases from national credit tenants. NNN translates to zero landlord responsibility. The tenant is in charge of paying taxes, utilities and insurance, as well as managing the everyday tasks of cleaning, landscaping, and changing lightbulbs.

Direct ownership: Another key selling point of NNN properties is that investors get the bond-like performance of the net lease that delivers cash flow, and they have the added bonus of an investment that is secured by the underlying real estate. Unlike buying stock in a publicly traded REIT, direct real estate ownership allows investors to claim all of the benefits that go along with it, including tax advantages of depreciation, direct control of the asset, and the ability to enjoy leverage to increase the potential return of the investment.

Investors can use real estate to create diversity within a broader investment portfolio, such as complementing a mix of holdings in stocks, bonds, and commodities. In addition, investors can apply that same diversification technique to their real estate allocations as they continue to build portfolios and personal wealth over time. Whether you are a seasoned real estate investor or just getting started, it may be advantageous to explore whether NNN investment could be your ticket to enjoying your freedom. Please contact Andrew Vu at 415-539-1120, or andrew@tcpre.com for a complimentary strategy consultation.