Investing In Real Estate – The Full Picture

Investing is an essential part of personal finance. It’s a way to grow your money and protect your future from inflation. However, not all investments are created equal . There are many asset classes, each with its own set of risks and returns, and an investor who wishes to invest in real estate should only do so after comparing said asset classes. In this article, we’ll compare six popular investment assets using historical performance data. We’ll also explore the concept of systematic and unsystematic risk and calculate each asset’s expected rate of return using the dividend discount model and capital asset pricing model.

Systematic risk is the risk that affects the entire market or economy. It cannot be diversified away by investing in different assets. Examples of systematic risk include changes in interest rates, inflation, and political events.

Unsystematic risk is the risk that affects individual assets or companies. It can be diversified away by investing in different assets. Examples of unsystematic risk include company-specific news, natural disasters, and management changes.

Real estate is a popular investment asset that includes properties such as homes, apartments, and commercial buildings. Real estate has shown consistent growth over the years and has a relatively low correlation with other assets. This means it can provide diversification benefits to a portfolio.

Over the past few decades, real estate has delivered an average annual return of around 10%, according to data from the National Council of Real Estate Investment Fiduciaries (NCREIF). However, real estate also comes with risks, such as vacancies, property damage, and natural disasters. These risks are examples of unsystematic risk, and the only way to try and lower it is through multiple rental properties in residential, or multiple high-quality businesses in commercial.

Expected Rate of Return: The expected rate of return for real estate can be calculated using the dividend discount model, which takes into account the expected future cash flows from the property. The expected rate of return for real estate is estimated to be around 7-8% pre-tax. We won’t look at the taxes here, but we do in our other article: Real Estate Investments Compared

Stocks are another popular investment asset that represents ownership in a company. Stocks have shown high returns over the long term, but with higher volatility and risks than real estate. The stock market can be affected by many factors, such as political events, economic conditions, and company-specific news. These risks are examples of systematic risk.

Over the past few decades, the US stock market has delivered an average annual return of around 10%, according to data from Standard & Poor’s (S&P). However, the stock market has also experienced significant downturns, such as the dot-com bubble in 2000 and the financial crisis in 2008, and more recently during the Covid-19 pandemic. Thus, stock investing should be pursued long-term (10+ years), rather than getting in and out of the market.

Expected Rate of Return: The expected rate of return for stocks can be calculated using the capital asset pricing model (CAPM), which takes into account the risk-free rate, the expected market return, and the stock’s beta. The expected rate of return for stocks is estimated to be around 8-10%.

Bonds are a fixed-income investment asset that represents a loan to a company or government entity. Bonds have lower returns than stocks but come with lower risks. However, bonds are still subject to credit and interest rate risk.

Over the past few decades, the US bond market has delivered an average annual return of around 5%, according to data from the Barclays US Aggregate Bond Index. However, bond returns can vary depending on the type of bond and prevailing interest rates.

Expected Rate of Return: The expected rate of return for bonds can be calculated using the dividend discount model, which takes into account the expected future cash flows from the bond. The expected rate of return for bonds is estimated to be around 2-4%.

Treasury bills are a type of bond issued by the US government with maturities of one year or less. Treasury bills are considered to be the safest investment asset as they are backed by the full faith and credit of the US government. However, they also come with the lowest returns.

Over the past few decades, US treasury bills have delivered an average annual return of around 3%, according to data from the US Department of the Treasury. However, treasury bill returns can vary depending on prevailing interest rates.

Expected Rate of Return: The expected rate of return for treasury bills is estimated to be around 1-2%.

Precious metals such as gold and silver have been used as a store of value for centuries. Precious metals are considered a safe haven asset as they tend to perform well during times of economic uncertainty or inflation. However, they also come with lower returns and high volatility. Over the past few decades, gold has delivered an average annual return of around 7%, according to data from the World Gold Council. However, precious metals returns can vary depending on economic conditions and demand.

Expected Rate of Return: The expected rate of return for precious metals is difficult to estimate as they do not generate cash flows. However, some analysts use the cost of production as a guide to estimate the expected rate of return for precious metals. The expected rate of return for gold is estimated to be around 2-4%.

High-interest savings accounts are a low-risk investment asset that offers higher returns than traditional savings accounts. They are usually offered by banks or credit unions and offer a guaranteed interest rate.

Over the past few decades, high-interest savings accounts have delivered an average annual return of around 2%, according to data from Bankrate. However, interest rates can vary depending on prevailing market conditions, as they are dependent on the federal funds rate. For example, Wealthfront is offering 4.05% on their acocunt.

Expected Rate of Return: The expected rate of return for high-interest savings accounts is the interest rate offered by the bank or credit union.

Investing is an important part of personal finance, but it’s important to understand the risks and returns of different investment assets so that an informed decision can be made on which one(s) to add to your investment portfolio. Real estate, stocks, bonds, treasury bills, precious metals, and high-interest savings accounts are all popular investment assets with different risks and returns. Real estate and stocks have shown higher returns over the long term, but come with higher risks, while bonds and treasury bills offer lower returns but with lower risks. Precious metals and high-interest savings accounts offer lower returns and come with high volatility and interest rate risk. It’s important to diversify your portfolio and consider your risk tolerance and investment goals when choosing investment assets. Turning to a real estate agent for investment help is only prudent if the agent is aware of the benefits and drawbacks of the other asset classes, and is able to take an unbiased stance. Lightning Lister Partner Agents are educated and tested on this, as real estate investing is not a part of the real estate education, but is a must in our view, to provide the best guidance to clients. To read a more in-depth view of Real Estate investing, please read our article: Real Estate Investments Compared

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