Commercial real estate can be a valuable addition to a well-balanced investment portfolio and has the potential to enhance returns while reducing overall portfolio risk by increasing diversification. However, commercial real estate has not always been an asset class which is readily available to most individual investors due to the private nature of most investment opportunities in addition to large dollar minimum investments.
Investment risk management has been debated and studied for decades. For example, the Capital Asset Pricing Model (CAPM) and the Modern Portfolio Theory (MPT) were conceived in the 1950’s and 60’s and are still two of the most well-known and accepted theories regarding portfolio risk management. Without getting too far into the details, these theories and most other risk management studies suggest that the best way to reduce the overall risk in any given investment portfolio is to diversify one’s investments among assets or asset classes which do not tend to correlate well with another in their price movements.
As an example of the above concepts, consider an individual buying stock in Verizon Communications and AT&T. While these two stocks will not move in lock-step, they will tend to move in a manner very similar to one another as their values will both hinge on similar news events and developments. So while an investor who purchased stock in both companies did achieve a theoretical reduction in risk through increased diversification vs. buying stock in only one of the two companies, the portfolio would still not be well diversified because the stocks tend to move in a highly correlated manner.
Now consider adding commercial real estate as an asset class to an already diversified portfolio of stocks and bonds. Historically, commercial real estate has had a relatively low correlation with the U.S. stock and bond market. Because of this, commercial real estate can serve as an ideal addition to an individual’s portfolio. This is a large contributing factor as to why most pension funds invest a portion of their capital in commercial real estate. If commercial real estate is not a part of your investment portfolio, perhaps it is something to consider.
Historically, most individual investors have had a difficult time identifying and/or gaining access to commercial real estate investment opportunities. Most investors do not have the necessary capital, time and expertise to generate their own commercial real estate opportunities. In addition, regulatory guidelines mandated that most real estate opportunities were handled privately among friends, family, and personal networks. This is because it was against SEC regulations for most commercial real estate opportunities to be offered or advertised to the general public.
The JOBS Act (Jumpstart Our Business Startups Act) was crafted and passed in 2012 under the Obama administration. Title III of the JOBS Act is also known as the Crowdfund Act. This Act changed the way many investments could be marketed and offered to the public, including individual commercial real estate projects. Through crowdfunding, commercial real estate investment opportunities are now advertised and available to the general public via the internet; although some investments are restricted to accredited investors. Minimum investment amounts vary by project, but these minimums are far less than the capital it would require for a person to execute a large project on their own. In the context of this discussion, the JOBS Act has the potential to forever change the way people finance and invest in commercial real estate. The Act has made commercial real estate investments more accessible and practical than ever before.
Crowdfunding has now made commercial real estate available to a much larger population of people. Now individual investors can access and invest in commercial real estate offerings online without an established social or professional network. Crowdfunding websites enable individual investors to pool their investment dollars to finance more sophisticated and larger projects. Further, because minimum investments are reduced via crowdfunding, investors can diversify their capital by investing in multiple projects if they so desire.
Those who are interested in a more diversified investment portfolio may want to look towards the benefits of commercial real estate. At Realty Mentors, we can help. Contact us today to learn more.