This investment option can help you hedge against inflation

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Legendary investor Warren Buffett has words of wisdom for anyone trying to get the most out of a long-term investment strategy. Diversification, he likes to say, is “protection against ignorance.”

All investors are ignorant about plenty of different markets, and according to this philosophy, spreading money around is a good way to follow the smart money. (At last count, the “Oracle of Omaha” had a net worth north of $100 billion.)

What is the definition of diversification?

Diversification is a risk management strategy, which calls for investing in various asset classes to mitigate exposure to loss and maximize earning potential. (We’re doing our best to not trot out the old metaphor of putting all your eggs in one basket, but honestly, it’s a little tough to avoid.)

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But diversification goes beyond investing in a portfolio of diversified U.S. and international stock funds, which most professional advisors recommend, since all that money is still in the equities market basket.

Real estate’s role in managing risk

With home prices popping in many markets across the country, it’s no easy task to find deals that will offer cash returns and appreciation so investors need to do their homework.

Or consult with experts.

“It’s highly competitive,” says Don Ganguly, senior vice president of Mynd investor services. “It’s going to require grit and persistence to get a deal done in the parameters you can afford.”

Interested investors can start their search with Zillow, partner with a local agent, or consult Mynd, an end-to-end real estate investment technology platform for investing in single family residential (SFR) properties.

“Investing in single family real estate allows you to be a bit granular, to take it one home at a time. Then you can expand and get up to 10 properties with the low interest rate,” Ganguly says. “We look at 25 markets and give investors information on data like pricing and returns on investment, and we have investment location managers who will help you take a deal over the finish line.”

Investing in real estate, especially single family residences, brings numerous benefits, such as substantial tax advantages, government-sponsored leverage, and cash on cash returns, defined as a property’s cash return from rental income against cash invested.

Once the investor graduates from a starter investment into more than one property, it’s wise to diversify into various markets to benefit from increases in home prices in one particular city while insuring against a downturn in other geographic areas. Mynd can serve the investor as a partner in 25 U.S. markets, from Atlanta to Austin, from Phoenix to Raleigh, from Las Vegas to Charlotte.

Real estate and bonds are an effective strategy

To further diversify, one can add bonds to a portfolio, which usually offer lower returns than stocks but are also much lower-risk. Depending on the investor’s age and risk tolerance, different balances of stocks and bonds are appropriate.

Real estate is considered low risk as well. But many American households are not invested in real estate apart from their homes, if that. Single family homes have seen high demand and chronic undersupply since the Great Recession of 2008, driving up values and returns for those invested in single family residential (SFR). What’s more, mortgage interest rates are lingering at historic lows, allowing investors to very favorably leverage their investments.

Sam Dogen, who writes the blog Financial Samurai, points out that per Census Bureau data, at the end of 2020, not even two-thirds of households owned their homes. That means about a third of the U.S. missed out on the post-2010 housing boom, he writes. What’s more, he observes that among homeowners, almost all of the average American’s worth is tied up in their residence.

Two types of perils that investors face

Investing is, by definition, always a game of prudently trading off risk versus return. Diversification can address some of these, but no strategy can outrun every risk.

What are the different kinds of risk? They go in two buckets.

Systematic risks are those that occur throughout a financial system and are unavoidable. For example, rising inflation or interest rates hit all industries. But there are ways to manage this risk to some degree, for example by buying commercial real estate or fixed-income assets like bonds.

By contrast, idiosyncratic risk is avoidable, and diversification manages this risk effectively. Examples of assets that have idiosyncratic risk are shares in a particular company — whose fortunes may rise or fall — or in a wider industry, like the energy sector or the auto industry.

Yale ‘s chief endowment officer diversified the university’s portfolio into real estate, as much as 20 percent in some years. (Credit: Yale University) 

Yale endowment’s real estate strategy sets the bar

Investment firms wanting to maximize their returns often look to Yale University’s endowment, which earned an impressive 13.2 percent annual return between 1985 and 2015, and was insulated from downturns during that span.

Under chief endowment officer David Swensen, Yale diversified beyond traditional assets, such as publicly traded stocks, into alternative investments, which are privately traded and are correlated at low levels to traditional assets. Over that period, the endowment’s investment in public market asset classes dropped from more than 80 percent to less than half. Notably, those included a healthy investment in real estate, as high as 20 percent in some years.

“People used to think of real estate investments as one step above bonds,” Rohan Parikh, real estate team leader at New York’s Altfest Personal Wealth Management, told Mynd. The general assumption was that stocks were what would really grow a portfolio. But Yale’s success devoting so much to real estate changed some people’s minds.

Others say that not everyone has learned the lessons of Yale.

“I think the Yale endowment model has as much misled investors as guided them correctly,” says Michael Rosen, chief investment officer at multi-asset firm Angeles.

Founded in 2001, Angeles has offices in New York and Santa Monica, California, and its 27 investment professionals oversee about $6.3 billion in outsourced investment management and over $38 billion in consulting relationships.

“Yale has significant material advantages that very few investors have,” Rosen says. “It’s not quite so simple for investors to replicate what Yale has achieved simply by following their asset allocation model.”

Indeed, individual investors’ profiles differ starkly from those of a university, not only in time horizon but, obviously, in scale: Yale’s endowment measured more than $31 billion at the end of fiscal year 2020.

But Swensen also created a model for individuals, which dictates that they should put at least 20 percent of their portfolio into alternatives such as real estate.

Why real estate acts as an inflation hedge

“Real estate is a great asset class to diversify into,” says Parikh.

His firm, which has been in the business for over three decades, has a team of 40 that manages $1.5 billion in assets for 650 client households.

“One of the reasons for this is that historically, real estate has been independently correlated with stocks and bonds,” says Parikh. “That in itself is a really good reason.

“Another is that it’s a good inflation hedge,” he adds. “If you have a single family property that you’re renting out, your rent goes up as inflation rises. Or, say you’re holding it for yourself. The value appreciates over time as inflation goes up.”

With inflation hitting a high of 6.2 percent annually in November, the time to put some cash in a more stable asset like real estate is now.

 

This article originally appeared on Mynd.co and was syndicated by MediaFeed.org.

 

More from MediaFeed:

25 ways you can start investing in real estate

 

Investing in property is a smart financial decision for several reasons. Real estate tends to appreciate in value over time, is viewed as safer than investing in the stock market, and offers great tax advantages. But it’s also known as the ultimate “get rich slow” scheme.

 

Typically, it will take years before the capital an investor earns on their property becomes liquid, and large sums of money are needed upfront to get started. Once your investments begin to compound, though, your portfolio will grow rapidly and your wealth will snowball.

 

As an investor, a general understanding of the buying and selling process will help immensely, so brushing up on the basics is highly advised. For example, the average realtor commission is 5.45%, but it is typically up to the seller to cover commission fees for both their own agent and the buyer’s agent.

 

Working with a knowledgeable local realtor will make the home buying process much less stressful, and tools like seller net sheets will help estimate how much you’ll receive from selling your property (after expenses).

 

If you’re trying to figure out the best type of property investment for your personal goals, then continue reading. This article will cover 26 different ways you can invest in real estate — from rentals to REITs!

 

Related: Real Estate Investing – A Complete Guide To Getting Started

 

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House hacking involves buying a duplex, triplex or fourplex, living in one of the units and renting out the rest. The monthly rental income the owner earns from their tenants usually covers the cost of their mortgage payments and property expenses—essentially allowing the owner to live there for free.

 

House hackers usually start out with just one property, but after the first couple of years, they are able to buy more properties with a mix of their rental and W2 income. After a while, they can live solely off of the profits from their rental portfolio.

 

 

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Flipping houses allows investors to purchase outdated properties at a lower price, renovate them and then sell them for a profit. Although this sounds easy in theory, it could quickly turn into a money pit if you do not have a solid understanding of all the repairs needed up front if the seller doesn’t pay for them when you buy the property.

 

Ascertaining the home’s After Repair Value (ARV) and using the 70% rule will help determine how much you should pay for a fixer-upper. The 70% rule states: When buying a fixer-upper, an investor should pay 70% of the property’s ARV minus the repairs needed.

 

(ARV) x 70% = X

X – ($ Repairs Needed) = What you should pay for the property

 

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Hard money lending is a good option If you have a large amount of capital but don’t necessarily want to manage a property.

 

In this situation, the investor would earn income by acting as the lender and charging monthly interest to the borrower. Interest on hard money loans are typically higher than average (ranging from 7.5% to 15%), but the loan’s duration is normally shorter (around 6-18 months).

 

House flippers tend to seek out hard money loans because they are faster to attain compared to a conventional mortgage and have fewer requirements surrounding the condition of the property.

 

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Becoming a landlord is what many people imagine when they think of investing in real estate. Long-term rentals are usually leased out for a year at a time and provide the owner with a steady stream of monthly rental income from their tenants. Being a landlord is not a walk in the park, though, and you will be responsible for repairs, maintenance, and any issues that arise with the home.

 

To determine an investment property’s true ROI after expenses, use a rental property calculator and do your research. Before spending thousands on renovations and expensive furniture, know that your tenants might not treat the property as kindly as you would. Rather, you should aim to “tenant proof” the home with features such as durable carpet for if and when damages occur.

 

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Vacation rentals, a.k.a short-term rentals, have huge potential to generate significant cash flow. Owners can charge more per night than a long-term rental and do not have to deal with difficult tenants (at least not for very long). Plus, platforms such as Vrbo and Airbnb have made renting out your space to vacationers more accessible than ever before.

 

Vacation rentals do require a lot of upkeep, and you’ll need to clean it after each stay, so keep that in mind as you’re calculating potential ROI.

 

Related: 12 Steps To Buy A Rental Property That Cash Flows

 

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REITs (real estate investment trusts) are companies that own income-generating real estate such as apartment buildings, hotels, shopping centers, etc. Most REITs are publicly traded on a stock exchange, although some are private.

 

Equity REITs are the most common type of REIT and offer investors the opportunity to buy into a portfolio of real estate assets without purchasing physical property. These investments usually produce high dividends, making them great for retirement accounts.

 

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mREITs, or mortgage REITs, purchase mortgage debt, mortgage-backed securities and other assets and earn income from the interest. Although with mREITs you are technically investing in the financial market, mREITs provide significant liquidity for the real estate market.

 

 

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Like regular mutual funds, real estate funds are run by a fund manager who makes all the decisions on what the fund to invest in. Their portfolio can consist of individual properties, a collection of properties, REITs or all of the above.

 

The fund manager will take a percentage of all invested capital as their fee, which is generally around 2%. Although REITs pay out dividends, real estate funds produce income through appreciation over time.

 

 

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Real estate crowdfunding platforms such as Fundrise and Realty Mogul have recently boomed in popularity. These platforms allow investors to purchase a piece of a larger property without managing it themselves. Unlike many REITs, the companies behind crowdfunding are not publicly listed and do not file with the SEC.

 

 

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Commercial real estate is leased out for business purposes, whereas residential real estate is leased out to individuals. Unlike residential contracts, commercial property leases usually last from 1-10 years. There four main types of commercial rentals are:

  1. Single-Net Lease
  2. Double-Net (NN) Leas
  3. Triple-Net (NNN) Lease
  4. Gross Lease

Commercial properties include shopping centers, office buildings, hotels, hospitals, gas stations, grocers, etc. These properties could be difficult for first-time investors because they are much more expensive than the average residential property and require significant maintenance.

 

If you are up to the challenge, then make sure to determine your capitalization rate ahead of time to estimate the rate of return on your investment after operating expenses.

 

Cap Rate = Net Operating Income / Current Property Value

 

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A 1031 exchange is an IRS regulation that allows investors to sell one property and buy another on a tax-deferred basis. Typically, an investor would have to pay taxes when swapping properties.

 

However, if the deal meets 1031 exchange conditions, then they do not have to pay taxes on any capital gains until they sell the asset for cash. Using this method is a great way to quickly build your portfolio.

 

 

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No, this does not mean the investor is “cold.” BRRRR stands for: Buy, Rehab, Rent, Refinance, Repeat.

 

You can think of the BRRRR method as a cross between house-flipping and owning a rental property. Essentially, an investor buys a distressed property listed at a low price, renovates it, rents it out to a trustworthy tenant, and then refinances the property at its new appraisal value. With the cash-out refinance, the investor can then buy another distressed property and repeat the process.

 

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Raw or vacant land can be a good investment that does not require tons of money up front and can produce high returns if done correctly. Investors can lease out the land, hold and flip it, or develop it. Owning vacant land also does not require much maintenance and does not have many expenses.

 

 

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Buying a multifamily or apartment building provides a plethora of ways to make a return on your investment. Owners will earn monthly rental income and great tax benefits, as well as the resale value of the property. Moreover, with creative financing and some research, you may be able to find an apartment complex at a lower price than you imagined.

 

 

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Mixed-use real estate is used for both residential and commercial tenants. A good example of a mixed-use property is an apartment building with retail shops on the first floor. Having this type of setup is smart because retail tenants have guaranteed foot traffic from the residents who live in the complex.

 

 

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Wholesalers find underpriced properties and then quickly flip them to an interested buyer at a higher price. They do not rehabilitate the property first but rather act as the middleman. Wholesalers earn income by keeping the difference between the price they paid for the property and the price they sell it for.

 

 

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Industrial real estate includes warehouses, manufacturing plants, research facilities, storage units, etc. Although this may not be what you immediately think of when it comes to real estate investing, industrial leasing has increased significantly in the past couple of years largely due to e-commerce.

 

 

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Homesharing is when the owner of a property allows a tenant to rent out all or a portion of their home. Homeowners can use platforms such as Airbnb to rent out their space for extra income. Another option is to find a roommate and charge monthly rent, which will then cover the cost of your home loan.

 

 

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A timeshare is a type of vacation property that has several owners who can each use the home at different times of the year. Although the time restrictions can sometimes be inconvenient, this can also be a way to dip your toe into real estate investing. If there is ever a year when you do not want to use the property at your allocated time, you can rent it out as a vacation spot.

 

 

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Finding several partners and investing in a property together can help those with limited funds break into the real estate market. By pooling your money together, your buying power and, consequently, the potential ROI will be much greater.

 

 

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Mobile home parks are when an investor purchases a parcel of land and allows individuals to park their mobile homes on the land for a fee. These types of investments are relatively low-cost and low-maintenance.

 

 

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Self-storage is a booming industry because, well, people have lots of stuff and need somewhere to put it! Renting out a self-storage facility is a good option for investors who do not want to deal with typical tenant relations.

 

 

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If a homeowner fails to pay their taxes, then the government will place a lien on their property. Tax lien investors essentially buy the delinquent tax lien and earn profits as the owner pays back the interest.

 

If the owner fails to pay back all of their delinquent taxes, then the person who bought the lien can take the deed of the property (which will also include taking on the property’s debts as well). Depending on the property at hand, buying tax liens can be incredibly lucrative.

 

 

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For those who have the capital, you may consider building a property from scratch and then selling it. Investing in new construction is basically the opposite of house flipping, and it’s less risky because there is no damage to address up front. However, building a home from scratch comes with its own risks, so make sure you have the time and bandwidth to deal with such a project.

 

 

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We saved the most obvious way to invest in real estate for last — buying a home! The act of simply purchasing a home for yourself is an investment. If you’re specifically looking to make significant returns once you sell your home, a local real estate agent can help you find a property in the right neighborhood at the right price.

 

Related:

This article
originally appeared on 
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syndicated by
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