How much Real Estate should be in my Portfolio?

A common question with investors is how much of my portfolio should be dedicated to real estate or alternative assets. My research and experiences on this subject would suggest the best way to handle it is in ranges. Those ranges can be very large. I know partners in our commercial real estate business who have almost all their assets tied up in their business, which happens to be investing in active and passive syndication deals. It’s not uncommon to see entrepreneurs have a large chunk of their net worth in their business in general. They know it well and are constantly reinvesting their time and energy into it. They may feel with this experience they have an “edge” and can outperform other assets that are available to them.

Experts, folks that manage large wealth portfolios for families (aka family offices) recommend anywhere from 10% to 50% of investor assets could be dedicated to real estate and alternative assets like private equity investments. Stocks and bonds typically make up the other piece of this pie. Investors often get exposed to stocks and bonds first through their employers 401K or through IRAs. The reason for this is that these markets have been around longer and are well established public markets that are highly regulated.  But most importantly I believe is awareness, the financial industry has spent billions advertising to us. In contrast, syndication or private offering deals in real estate or other alternative asset classes, in general, cannot be advertised nor are they available unless you are an accredited investor and have a relationship with the deal sponsor. Some exceptions have emerged such as crowdfunding (see SEC Reg D, 506 c) but there is still a large gap in education and awareness of opportunities in real estate and alternative assets.

That is gradually changing as we see a strong appetite for real estate, more evidence of long term wealth being created by this asset class and other alternative assets that may not have a strong correlation with the overall economy or stock market. Places like BiggerPockets forums, real estate dedicated podcasts and blogs where the masses are learning about the benefits of real estate have also helped level the playing field and bring education and awareness.

Real estate and alternative asset classes can provide some balancing and downside protection to one’s stock and bond portfolio. When something is out of favor and falling like stocks, the idea is that some of your other assets don’t march off the cliff in unison. Additionally, real estate offers inflation protection, tax benefits and cash flow that is hard to beat in other asset classes.  

In a related blog post Forget Bonds Buy Real Estate I make a point that you may want to reconsider bonds since yields are so low and provide no tax advantages and take a closer look at lower risk MF syndication deals with the right structures.  We are seeing multi family deals where syndicates are offering two classes of shares, one for the income investor with no upside but a 10% annual yield paid monthly or quarterly. Since the equity raise is limited for this class of investor and they are first to be paid (in front of the Class B growth investor) the risk of loss is statistically very low.  The Class A investor also has the tax benefits as an equity participant that flow through to them as a limited partner.  Essentially, its like a 12-13% pre-tax return in an asset and deal structure that according to our analysis would have held up just fine during the last 2007-2009 crash.

So, here are my quick tips on the asset allocation question:

Get educated.  Then choose an allocation percentage that you feel comfortable with (10% to 50%). Start slow and at the lower end and as you get more sophisticated and experienced, you will probably increase towards the mid to upper end of this range.

Once you choose your overall percentage, start with low risk commercial real estate assets that have proven very durable in even down markets. You get a healthy dose of these opportunities sticking with value-add apartments, self-storage and manufactured home parks (MHPs) which have proven to be top performers in the commercial real estate space because they don’t crater in down times. Read my blog Growth with Downside Protection - 3 Niches

I slightly favor apartment investing then add some MHPs and self-storage deals. I’m fine with single asset plays in apartments but prefer a fund approach when it comes to storage and MHPs to further reduce risk of single asset investing.

Within these three niches, I would like to further diversify and reduce my risk by geography and operator so that I’m not overly focused on one market or operator.  Read Diversification Tips

Lastly, I keep my eyes on maybe a few very promising alternative assets plays if I’m a bit more risk averse, looking to slightly sweeten overall returns while providing further downside protection that non-correlated assets can deliver.