It is estimated that in 2020, approximately $63.07 billion worth of assets were under investment funds management globally. These funds include Pension Funds, Hedge Funds, Mutual Funds and Sovereign Wealth Funds.
Generally, Asset managers seek investment opportunities that help them to hedge their portfolios across borders, among different asset classes and across industries. The allocation into direct and indirect real estate investments which has been traditionally low has experienced a resurgence, from about 6% to above 15%.
What has increased the desirability of real estate in the diversification of portfolios? And how can real estate serve the value preservation criteria for individuals and institutions?
Modern Portfolio Management strategies show that that diversification is best amongst assets that have varying investment characteristics. Such assets have very low or negative similarities in behavior until one reaches the point that unsystematic risks are eliminated.
It is a known fact that inflation erodes the return on investment on assets over time. In Nigeria, inflation is currently 17.75% implying that an investment of N100 12 months ago has lost approximately N18 within the period.
Therefore, if the rate of returns is not outpacing inflation, the investment will effectively be earning negative returns. Additionally, if the fundamentals of the asset are highly similar to the economy, the ability to earn projected returns will match the prevailing economic indices.
These lead to the question: How does real estate earn returns? Simply put, it comes in two way s- revenue from rent (from finished residential buildings, office spaces, hotels and recreational centers) and capital appreciation which represents the difference between the cost of acquiring a real property and its value today.
It has been observed that in the mid to long-term, real estate provides the most stable returns among the major asset types. Unlike investments in the stock market which are relatively unpredictable, real estate generally allows the investor the comfort of stability through the signing of multi-year lease agreements, and the fact that the investment is covered by a physical underlying asset.
For instance, although the NSE All Share Index gained 47.5% in 2020, it suffered a loss of 14.36% in 2019. On the other hand, a 3-bedroom flat in Lekki which was valued at N38 million in 2016, and was commanding an annual rent of N2.5m is now valued at about N55m.
This will be equivalent to an annual return of 16%, surpassing the average inflation rate of 13.8% over the corresponding period.
From the example, property acquisition has hedged the investment returns from inflationary erosion and extreme macro economic volatility over the 5-year period.
Therefore, investment in real estate as a diversification strategy is increasingly adopted by Asset Managers. A study in the US from 1960- 2000 showed that over any 10 year period, real estate outperforms all other asset classes.
The major problems associated with real estate investment however are the high barrier to entry and issues regarding the liquidity of the asset. Investors will usually have to commit significant funds for the acquisition of the asset(s). These funds are then “locked down” and the investor has to wait until a buyer can be identified at an acceptable price.
These issues can be sidestepped by investing in indirect real estate investments which require lower minimum commitment. This allows the investor to benefit from investment in real estate while eliminating the issues listed above.
Available indirect real estate investments include:
- RE Collective investments
- RE Project financing
- RE Mutual Funds
- Real Estate Investment Trusts (REITs)
However, it is best advised to consult the services of a Financial Adviser to make recommendations and review proposed investments so as to match you with the type of investments that would fit your overall financial goals.