One of the most effective strategies for diversification is to use property in an investment portfolio. It offers unique benefits over stocks and bonds because its value will often be in contrast to the movements in these markets. That means when one is up the other will tend to go down and this reduces overall volatility. It also offers advantages when the economy is in a downturn because there will still be good returns from dividend income.
There are two ways in which to use property in an investment portfolio. Publicly traded Real Estate Investment Trusts (REITs) are one option or the more traditional form or investing directly in real estate can be used. There are various benefits of either option but the best results are seen when they are used in combination.
Working out how much of either should be purchased can be done using mean-variance analysis. For this to be done it is necessary to make use of a reliable index. This is easier to achieve with REITs as there is ongoing data being generated by regular trades. With privately owned real estate it is more difficult to get a clear idea of volatility as they are not bought and sold on a regular basis.
The index for private real estate is the NPI which is released on a quarterly basis. It would be more useful if the results could be seen weekly but considering that information has to be submitted on ever purchase which takes place or on an appraisal this could never really be possible. The NPI does have sub indexes which give a better estimate related groups such as industrial, office, retail, apartments and hotels.
Diversification is primarily used to balance out the risks found in different markets. It cannot counteract general effects of the economy and there is always some risk regardless of what strategy is employed. It is found for example that all markets react to fluctuations in GDP with some lag. The advantage of property though is that it is still a hedge against inflation.
When using REITs there will be better returns but there will also be more risk. To get the best result a combination of private direct investing, which has low volatility, and REITs should be used. Although they have higher tax implications than stocks and bonds this is not as much of an issue when the accounts have tax benefits so as with 401K’s or IRA’s.
The highest efficiency that was determined by a study by Feldman (2003) was 2/3 private real estate and 1/3 REITs and they overall allocation for property in an investment portfolio could be up to 44.5%. This is because the higher volatility of REITs needs to be counteracted. At the same time the benefits of its higher yields can still be taken advantage of.
Including real property in an investment plan has some decided advantages, including less likelihood of property depreciation. Obtaining the services of a quantity surveyor Gold Coast company helps to valuate your property.
