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Alternative Investments: Real Estate as a Portfolio Diversifier

Picture: Downtown Storefronts Investing in real estate can be a smart way to generate passive income and achieve long-term returns. As the equity and bond markets become increasingly volatile, real estate offers a valuable diversification...

A picture of downtown storefronts. Picture: Downtown Storefronts

Investing in real estate can be a smart way to generate passive income and achieve long-term returns. As the equity and bond markets become increasingly volatile, real estate offers a valuable diversification opportunity for a well-managed portfolio. When stocks or bonds face a downturn, directly owned real estate tends to maintain its value due to its low correlation with these markets[^1^].

However, it's worth noting that publicly traded real estate investment trusts (REITs), which resemble stocks and are traded on public exchanges, have a higher correlation with the stock market. While investing in REITs can be convenient, their easy liquidity makes them vulnerable to market fluctuations, potentially jeopardizing the diversification benefits they offer. Sometimes, things that are too easy to sell can be a double-edged sword[^1^].

Portfolio Considerations

Before adding real estate to your investment portfolio, it's crucial to assess your overall risk tolerance and investment strategy. Your goals may include generating regular cash flow to cover living expenses or seeking capital appreciation with value add or opportunistic investments[^2^]. The size of the real estate allocation in your portfolio typically ranges from 5% to 10% for a diversified managed portfolio. The exact allocation within this range depends on the characteristics of the real estate assets you are investing in. Diversified core or core-plus real estate portfolios may warrant a higher allocation, while riskier or less diversified investments may require less than 5%[^3^].

When allocating funds from an existing portfolio of stocks and bonds to real estate, consider the specific characteristics of the investment. For instance, a core-type property investment with stable income streams can be funded partially from fixed-income allocations. On the other hand, investments involving significant leverage or higher speculation may necessitate funding from equities. Understanding how different elements of your portfolio interact with each other is key to successfully integrating real estate into your investment strategy. Remember, there are no one-size-fits-all solutions, so always consult with your investment advisor to align your portfolio with your specific goals, risk tolerance, and timeline[^3^].

Investing for Diversification

How can you achieve the benefits of diversification while minimizing the risks associated with highly liquid REITs? One approach is to build a portfolio of directly owned real estate properties in different locations and property types. This method requires substantial capital and considerable management responsibility. However, professional asset managers can provide assistance in handling these tasks. Another option is to invest in professionally managed private partnerships or investment funds. By doing so, you can access the expertise and scalability of professional real estate managers while requiring significantly less capital compared to independent investments. Unlike REITs, these less-liquid structures typically have preset exit intervals and the managers can halt redemptions if necessary to protect the long-term interests of investors[^4^].

Levels of Risk in Real Estate Investing

As with any type of investment, it's important to understand your own risk tolerance and objectives when developing a real estate portfolio. Real estate strategies can be broadly categorized into four risk-return levels:


Core assets have the lowest potential return but also the lowest risk. These are prime properties in desirable locations with high occupancy rates. They provide stability and security for investors[^5^].


Core-plus assets are similar to core properties but may have slight deficiencies that demand higher returns. For example, a property historically leased at 95% occupancy is sold with 88% occupancy, requiring the investor to lease up the property to stabilize returns[^5^].


Value-add investments involve acquiring properties that require improvements such as new appliances, floor coverings, or countertops. By making these enhancements, investors can increase rental income and achieve additional returns while assuming construction and timing risks[^5^].


Opportunistic investments carry the highest level of risk. They often involve ground-up developments or distressed properties that may not generate cash flow for one to three years. Delays in construction, unexpected costs, and market uncertainties increase the risk profile of these investments. Recent media attention has focused on opportunity zone investments, which offer attractive tax incentives but should be approached with caution[^5^].

Evaluating a Real Estate Investment

When evaluating a potential real estate investment, consider the following factors:

  • Fund manager: Assess the manager's track record, experience, and ability to execute investment strategies. Consider their performance relative to peers and evaluate their approach to risk management and downside protection.
  • Market volatility: Analyze the stability of the market in terms of geography and property type. Determine the timing of the investment within the market cycle.
  • Diversification of property type: Look for a well-diversified portfolio that includes various property types and geographical locations[^6^].

Once you are comfortable with the fund manager and their strategy, conduct a detailed analysis of the opportunity. This analysis may include assessing the basis and returns, understanding revenue, occupancy, expenses, capital improvements, and management fees. Leverage should be considered carefully to ensure it aligns with the investment's risks and timeline[^6^].

Investors should rely on the expertise of their advisors when performing due diligence on real estate funds. By collaborating with a multidisciplinary team, including real estate, tax, and investment professionals, you can make informed decisions that align with your overall investment plan[^6^].

Plante Moran Investment Advisory Team

Taking a top-down approach to real estate investing involves identifying investments that align with your overall investment portfolio, real estate strategy, and objectives. Given the complexity and potential risks of real estate investing, it's beneficial to have a team of professionals evaluating and structuring opportunities. At Plante Moran, we leverage the expertise of our real estate, tax, and investment advisors to provide attractive investment opportunities tailored to your specific needs. To discover more about real estate as an alternative investment, feel free to reach out to us and schedule a consultation[^7^].

In conclusion, real estate can be an effective portfolio diversifier for the right investor. By carefully considering your risk tolerance, investment strategy, and the various levels of real estate investments available, you can build a robust and well-balanced portfolio that withstands market volatility and generates attractive returns in the long run.

This article was created with the insights from Plante Moran, a trusted investment advisory team.

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