Fiddich Review Centre
Alternative Investment

Do real estate investments provide diversification?

From investing in REITs to private real estate funds, MICs and farmland, real estate can balance a portfolio, and lessen its volatility

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A continued drive for diversification in the face of economic uncertainty has many investors looking to alternative investments, including exposure to real estate. However, there are different options to achieve real estate allocations, each with its unique risks, expected rate of return, volatility and duration.  

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“Looking back at most recent years and especially since the beginning of 2022, a traditional 60/40 portfolio may not work,” says Martina Longauer, senior investment advisor with Sightline Wealth Management, an independent wealth management firm specializing in alternative investment strategies. “When stocks and bonds are losing their value at the same time, investors may look to diversify beyond traditional investments and into alternatives such as real estate.”

However, some investors may be concerned about devoting a high percentage of their portfolio to direct condo or home ownership to gain real estate exposure.

“I recently attended a new development presentation, and the cheapest unit was priced at $800,000,” Longauer says. “The salesperson made attendees feel there was no other option to allocate capital to real estate unless they paid 20 per cent down for the cheapest unit in a development that would not get finished for another 15 years. But investors have multiple options to include real estate in their portfolios using much less capital.”

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Longauer aims to expand the horizon of what investing in real estate can mean to investors, without looking through the narrow lens of direct home or condo ownership. That could include: real estate investment trusts (REITs), or private real estate funds, which feature investment-grade real estate; lending investment vehicles, such as mortgage investment corporations (MICs); and even investments in farmland.

Public REITs can represent residential, retail, commercial and industrial spaces, hotels, health-care facilities and self-storage units. GETTY IMAGES
Public REITs can represent residential, retail, commercial and industrial spaces, hotels, health-care facilities and self-storage units. GETTY IMAGES

“If investors choose (real estate) carefully they can achieve steady and predictable income and lessen the volatility of their portfolios,” she says.

When looking into private REITs, investors need to consider a firm’s portfolio of properties. What are the valuations of properties when acquired? What are their occupancy rates? What are their cap rates (net operating income divided by property asset value) and their sensitivity to interest rates? Who manages the properties, whether outsourced or in house? What are the mortgage rates on property portfolios and their duration?

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“After all these details are examined, the capital allocated to carefully selected private REITs can reward investors with competitive yields and tax-efficient income, with possibly less volatile assets compared to public markets,” Longauer says.

Public REITs come in an array of flavours, representing anything from residential (apartment buildings, student housing) to retail, commercial, industrial, hotels, health-care facilities and self-storage units. Sightline also offers exposure to an emerging class of well-managed REITs representing data centres and wireless communications towers.

“If you know the historical yield on a REIT, you can buy those units at a very attractive price when the market is surprised by the shock of another interest rate hike,” Longauer says. “You can then lock in a very nice, stable yield over the long term and capitalize on it for an extended period.”

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Farmland funds purchase agricultural land and then lease it back to farmers. GETTY IMAGES
Farmland funds purchase agricultural land and then lease it back to farmers. GETTY IMAGES

Public REITs are extremely liquid, because they’re traded and sold like stocks, and they can trade with a discount or premium to their net asset value at any given time. On the other hand, private REITs are less liquid and are open only to accredited or eligible investors.

Longauer notes that private REITs can also exhibit less volatility because they aren’t publicly traded: “They’re not generally subject to market sentiment and there are rarely any big price swings as the price is largely consistent with the real estate portfolio valuation and income they produce. Even though their price can be sensitive to interest rates, it’s not to the same degree as publicly traded REITs.”

Both public and private REITs have the potential for tax efficiency when held in non-registered accounts, because distributions may be taxed as return of capital — although when sold at a higher price they can trigger capital gains.

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As another alternative to fixed-income investments, MICs pool the investment capital of private investors into private mortgages in Canada to provide a steady source of income. Annually, 100 per cent of a MIC’s net income is distributed to shareholders as dividends fully taxable as interest income.

MICs that one might consider favourable are managed by teams that understand how to read the market properly, even in an unfavourable economic climate, so they don’t spread themselves too thin,” Longauer says. “If they’re managed right and across optimal duration, they can produce regular, reliable income.”

However, MIC investors must also consider multiple risks, including housing bubbles, capital allocated to illiquid properties and the credit quality of borrowers. With a number of MICs offered in the marketplace, investors should consult with a professional before making a choice.

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Investors can also invest in farmland units through farmland funds, which purchase agricultural land and then lease it back to farmers. The funds can be diversified across geographic regions and crop types. Farmland funds typically provide stable returns but perform best over long holding periods.

“Properly allocated, real estate can offer welcome portfolio diversification,” Longauer says. “By working with a seasoned advisor, investors can match their real estate investments to their appetite for risk, need for income and their investment time horizon.”

For more information on investing in real estate as part of a diversified portfolio, visit Sightline Wealth Management or call toll-free: (855) 943-4383.

This story was created by Content Works, Postmedia’s commercial content studio, on behalf of Sightline Wealth Management.

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