Benefits of Investing in Real Estate

Based on studies of  Indian real estate market studies,  private market commercial real estate returned an average of 12% over the past five years. This credible performance was achieved, together with low volatility relative to equities and bonds, for highly competitive risk-adjusted returns.

Critics argue that the low volatility characteristic of real estate is the result of infrequent real estate transactions and property values often determined by third-party appraisals, which tend to lag the market. The infrequent transactions and appraisals result in a smoothing of returns, as reported property values underestimate market values in an upturn and overestimate market values in a downturn.

While it’s true that historic estimates of real estate volatility should be adjusted upward, real-time markets are vulnerable to sudden unexpected shocks. 

Unlike stocks, and to some extent, bonds, an investment in real estate is backed by a high level of brick and mortar. This helps reduce the principal-agent conflict or the extent to which the interest of the investor is dependent on the integrity and competence of managers and debtors. Even real estate investment trusts (REITs), which are listed real estate securities, often have regulations that mandate a minimum percentage of profits be paid out as dividends.

A key feature of real estate investment is the significant proportion of total return accruing from rental income over the long term.  This helps reduce volatility as investments that rely more on income return tend to be less volatile than those that rely more on capital value return.

Real estate is also attractive when compared with more traditional sources of income return. The asset class typically trades at a yield premium to Government  Treasuries and is especially attractive in an environment where Treasury rates are low.

Another benefit of investing in real estate is its diversification potential. Real estate has a low and in some cases negative, correlation with other major asset classes. This means the addition of real estate to a portfolio of diversified assets can lower portfolio volatility and provide a higher return per unit of risk.

The inflation hedging capability of real estate stems from the positive relationship between GDP growth and the demand for real estate. As economies expand, the demand for real estate drives rents higher and this, in turn, translates into higher capital values. Therefore, real estate tends to maintain the purchasing power of capital by passing some of the inflationary pressure on to tenants and by incorporating some of the inflationary pressure in the form of capital appreciation.