What Role Does Real Estate Play in Investment Portfolio Diversification?
Diversifying your investment portfolio is as important as saving money for your future. Many experts believe that not investing your money properly is like throwing your hard-earned money away in the long run. With each market dip, you overexpose yourself to financial risks, if you have not properly diversified your financial assets.
Investment diversification is the key to combating financial market challenges. Most people wonder if investing in real estate is a good idea to diversify their investment portfolios or not. Let’s find out.
The Role of Real Estate in an Investment Portfolio
Real estate is a fundamental part of investment portfolios as it acts as a hedge against:
- The volatility of stock market returns
- Rising inflation
- And under certain conditions, increasing interest rates
Not only can real estate offer a great value that you can benefit from while selling it at profit, but it can also help produce significant returns when you earn income through long-term lease or rental contracts.
In short, in an asset-liability framework, real estate investments can work pretty well. The chances of suffering a huge loss on real estate over a long time are considered quite low.
Why Do Investors Include Real Estate in their Investment Portfolio?
Here is why more and more investors are including real estate in their investment portfolios:
Rental income
The most attractive part of investing in real estate is the prospect of resilient rental income. Unlike other income-bearing products such as government bonds, income generated from commercial real estate is very appealing. While dividends from equity-based investments are more discreet, rental income from real estate is contractually agreed upon and offers higher security potential.
Less Volatility
Though the income generated from real estate may be influenced by temporary volatility, its cycles are less pronounced. Long-term rental or lease contracts can help mitigate the impact of economic fluctuations on income as it remains usually consistent even during times of economic crisis. History has shown that real estate investments exhibit greater stability and returns over the longer term.
Portfolio Diversification
The low correlation of real estate returns with equities and fixed-income products is one of the main reasons why it is recommended to include real estate in portfolios. Commercial real estate with established and long lease terms is a longer-term and meaningful investment to reduce portfolio volatility through diversification.
Is Real Estate Investment a Good Idea to Diversify My Portfolio?
According to the 20% Rule – a popular method, one should consider at least 20 percent of investments into alternatives to stock markets, typically real estate. However, opinions may differ based on location. Usually, an expert will determine and recommend real estate investments depending on current economic conditions and if it is ideal for your financial situation.
Are there risks with real estate investment?
As with any investment, there are risks associated with real estate investments as well because they are typically bulky and illiquid. As an investor, you must be prepared to get through extended periods of very low liquidity when assets are difficult to sell.
Rising interest rates can negatively affect your investment as it reduces the property’s current value and the relative appeal of rental income streams. Other factors such as the increased supply of real estate in response to higher demand may affect the value of your property in the future.
However, diversifying the real estate portfolios across different locations and property types can help reduce the potential impact of such risks.
Do you need expert advice before investing your money or diversifying your investment portfolio in the UAE? Connect with our financial advisors at +971 4 3573378 or write to us at info@newageib.com.
