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When I have those inevitable conversations with strangers about what I do for work (managing a real estate investment club), their first question is often, “So how should I add real estate to my investment portfolio?”
There’s no one-size-fits-all answer to that question. It depends on the rest of their portfolio, their goals, their age, their risk tolerance — the list goes on. For example, I largely replace bonds with real estate in my portfolio, which means my real estate investments serve needs that you might not have.
Still, real estate can help shore up your investment portfolio in many ways. Try these real estate investments to serve specific roles in your portfolio.
Overview: Stocks vs. real estate
I’m not one of those real estate evangelists who refuses to invest in stocks. Stocks come with their own strengths and weaknesses, which complement real estate well.
Birkenstock goes public on the NYSE at the New York Stock Exchange on October 11, 2023 in New York City. (Photo by Jemal Countess/Getty Images for Birkenstock)
In particular, stocks offer liquidity, long-term growth, and ease of diversification across regions and economic sectors. You can easily invest in stocks in a tax-advantaged account such as an IRA, 401(k), HSA, or 529 plan.
And did I mention that they’re easy to invest in? You can invest in a broad, passive index fund and call it a day.
Real estate comes with different and often opposite advantages. It’s not liquid at all. In fact, it’s so illiquid that it’s almost always a long-term investment. But it typically generates strong cash flow, comes with inherent tax advantages that don’t require special tax-sheltered accounts and offers strong protection against inflation.
And, like stocks, it’s no slouch for long-term growth either.
As for average returns, real estate and stocks perform similarly. One massive study comparing 16 countries over 145 years found that real estate beat stock returns, slightly. If you compare the S&P 500 to U.S. REITs over the last 50 years, the S&P 500 barely edges out REITs.
I invest in both for diversification and to complement each other. I can enjoy the cash flow and direct tax benefits from my real estate investments now, even as my stock investments compound tax-free in my Roth IRA to fund my retirement.
Roles of specific real estate investments
A house hack serves a completely different purpose than a real estate syndication or a REIT.
Make sure you understand how each of the following investments fits into your portfolio.
Your primary residence
I have a whole rant about how you shouldn’t justify overspending on a home by calling it “an investment.” Housing is a living expense, it adds a line item to your budget every month, yada yada yada.
Now that we’ve gotten that out of the way, there are a few exceptions.
First, if you house hack, you remove housing as a living expense for effectively free housing. You can house hack in many ways, from renting rooms to housemates to adding an ADU to renting out storage space and beyond.
But the classic house hacking technique involves buying a two to four unit multifamily property, moving into one unit and renting out the other(s). Your neighboring tenants cover your mortgage payment, ideally with extra to cover maintenance, repairs, vacancy rate and so on.
Why two to four units? Because properties with up to four units count as residential for loan purposes. You can take out a conventional, VA, USDA or FHA loan to buy a multifamily with up to four units. In fact, you can use the future rent to help you qualify for the mortgage.
The other way to approach your home as an investment is to build equity over your working career so that you can live mortgage-free once you retire. That reduces how much money you need to save for retirement, since you’ll have lower living expenses.
You could retire in the same home you’ve lived in for the last 15-30 years of course. Or you could take the equity you’ve built in your family home and put it towards buying your retirement home in cash. Either way, the important thing is that you don’t refinance or otherwise tap your home equity.
REITs
Real estate investment trusts come with their share of advantages, and one giant disadvantage so egregious that I mostly avoid them.
These publicly-traded stocks offer liquidity, access to specific niches such as self-storage or retail, and often high dividend yields. They also provide an easy way to invest with little cash.
Typical Cape Cod style house, with a white picket fence in American suburbia.
What they don’t do is provide diversification from your stock portfolio.
A Morningstar study over several decades found that U.S. REITs share a correlation of 0.59 with the S&P 500. That makes REITs just another sector of the stock market, with a similar correlation as consumer staples, telecommunications stocks, and energy stocks.
If you just want a short-term way to invest for dividends, try these high-dividend REITs. But if you, like me, invest in real estate as a counterweight to your stock portfolio, look further afield.
Real estate crowdfunding
There are dozens of real estate crowdfunding companies out there, ranging in quality from excellent to suspicious. I’ve invested in many of them myself, as a low-correlation way to invest small amounts in real estate.
Today, I mostly invest in short-term real estate crowdfunding investments. Specifically, that includes Groundfloor, Concreit and Ark7.
The returns won’t knock your socks off. Concreit currently pays a dividend yield of 6.5 percent, but lets you withdraw your money at any time. Groundfloor averages around 9.5 percent to 10 percent on its hard money loans, and 5.5 percent to 7 percent on its short-term notes.
I expect returns between 6 percent and 10 percent from fractional rental property shares on Ark7, but they have a secondary market that lets you sell shares after a one-year holding period.
But these offer rare short-term investments in real estate, with low correlation to the stock market. They let me park my money for solid returns in the short term, while I invest for higher long-term returns in real estate syndications.
Real estate syndications
Don’t be intimidated by terms like “real estate syndication” or “private equity.” A real estate syndication is simply a group investment in a large property, such as an apartment complex or mobile home park or self-storage facility.
You buy fractional ownership in a large property, which entitles you to cash flow, appreciation, and full tax benefits. Best of all, you don’t have to become a landlord. You don’t have to hassle with loans or contractors or inspectors or renters or property managers.
Actually, that’s not the best part. The best part is the high returns, typically in the 15-30 percent range.
So why doesn’t everyone invest in real estate syndications?
The short answer: They’re designed for the wealthy. Most only allow accredited investors to participate, because of how Uncle Sam regulates them. Even the ones that allow all investors require a high minimum investment, typically $50,000 to 100,000. This is precisely why SparkRental created a co-investing club, allowing members to access these with much smaller amounts.
I invest in syndications as my primary real estate investment, and don’t mind locking up my money for the typical two to seven years in exchange for high average returns.
Investment properties
You know how the rental property model works. Property owners enjoy cash flow, appreciation, tax benefits, and the ability to leverage other people’s money. You can forecast the cash flow before buying, either with a long-term rental property calculator or an Airbnb calculator.
But most people don’t realize just how much work rental properties require. It takes work to find good deals, because I can tell you firsthand they’re not just lying around the MLS. It takes work to vet those deals, arrange financing and close on them.
Then come the negotiations with contractors, overseeing the repairs, the permit applications, the city and state inspections. Then the marketing for vacant units, the tenant screening, the lease haggling and deposit collection and chasing down delinquent tenants for rent.
Oh, and don’t forget learning your local landlord-tenant laws, which you need to follow or face the wrath of The Law.
Word to the wise: Only become a landlord if you’re passionate about creating a real estate side business. If you just want the returns and tax benefits, stick with syndications.
Real estate in my portfolio
Personally, I sold off my rental properties a few years ago. They just came with too many headaches.
Today I aim for around 50 percent to 60 percent of my portfolio in stocks, and 40 percent to 50 percent in real estate. I aim for as much diversification as I can in both, with small amounts of money spread across dozens of real estate syndications in our co-investing club. That includes properties in over a dozen states, spanning properties from multifamily to mobile home parks, retail to industrial, hotels to short-term vacation property portfolios.
While most are long-term investments, they pay me ongoing cash flow, which I certainly enjoy. When I need to park money short-term, I put it in the real estate crowdfunding platforms outlined above.
The stock market periodically crashes, and I don’t panic because I keep collecting cash flow from real estate. Property markets too sometimes struggle, and I don’t panic because a bad seller’s market means a good buyer’s market. I just keep investing small amounts, month in and month out, knowing that I’ll come out ahead in the long term.
Stay calm and keep investing. It’s that simple.
G. Brian Davis is a real estate geek and co-founder of SparkRental.
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