In today's dynamic financial landscape, savvy investors are increasingly turning to alternative real estate investments to diversify their portfolios and potentially boost returns. This comprehensive guide will walk you through the essentials of this exciting investment category, equipping you with the knowledge to make informed decisions and potentially enhance your financial future.
What Are Alternative Real Estate Investments?
Alternative real estate investments encompass a broad range of assets that fall outside traditional investment categories. These investments offer unique opportunities in the real estate market, often with different risk-return profiles compared to conventional property investments.
Alternative investments encompass all asset types outside the scope of traditional investments. In the realm of real estate, this might include investing in real estate investment trusts, renting out commercial real estate, and various other options we'll explore later in this article.
This category can include both direct real estate investments - such as purchasing property - and indirect real estate investments. These may require individuals to invest through a sponsor, such as a large financial firm or smaller syndicators, to access real estate opportunities not available in the public market.
Direct investments involve hands-on management and ownership of physical properties. This could mean purchasing a rental property, flipping houses, or developing commercial real estate. On the other hand, indirect investments allow you to gain exposure to real estate without the responsibilities of property ownership. These might include investing in REITs, real estate mutual funds, or participating in crowdfunding platforms.
The world of alternative real estate investments is vast and varied, offering opportunities for investors with different risk tolerances, capital availability, and investment goals. Whether you're looking for passive income, long-term appreciation, or a hedge against market volatility, there's likely an alternative real estate investment strategy that aligns with your objectives.
What Makes them "Alternative" Investments?
Alternative investments are asset classes that do not include stocks, bonds, or cash. These types of investments differ from traditional ones as they are not easily sold or converted into cash. They are also commonly referred to as alternative assets.
The primary reason to get into alternative investments is portfolio diversification.
Alternative assets have a low correlation to standard asset classes, so even if the stock market trends downward, that doesn't mean your alternative holdings will. Over time, this can make for improved investment returns.
According to a study on portfolio diversification, adding alternative investments to a traditional portfolio of stocks and bonds can potentially enhance returns while reducing overall portfolio risk. This is because alternative investments often move independently of the stock market, providing a buffer against market volatility.
It's no surprise that the KKR 2023 Family Capital Survey found that family offices utilize a significant allocation to alternative assets, as it usually makes for substantial returns. The survey revealed that family offices allocate an average of 52% of their portfolios to alternative investments, with real estate being a significant component of this allocation.
The "alternative" nature of these investments also often means they're less liquid than traditional investments. While this can be a drawback in some situations, it can also lead to potentially higher returns as compensation for the illiquidity risk. Additionally, alternative investments are often less efficiently priced than traditional investments, creating opportunities for savvy investors to capitalize on market inefficiencies.
Benefits of Alternative Real Estate Investments
Alternative real estate investments offer several compelling advantages that make them attractive to many investors:
- Decreased volatility: Most alternative asset classes are not correlated with the broader stock market, reducing portfolio volatility during economic fluctuations. This characteristic can provide a cushion during market downturns, helping to smooth out overall portfolio returns over time.
- Tangible asset: Investments in some alternative real estate options are tangible, instilling peace of mind and offering a more trustworthy security for the investment. Unlike stocks or bonds, real estate is a physical asset you can see and touch. This tangibility can provide a sense of security and stability, especially during times of economic uncertainty.
- Potential passive income: Passive real estate investing opportunities in alternative real estate can be income-producing, offering investors a potential steady stream of cash flow without active management. This could come in the form of rental income from properties, dividends from REITs, or interest payments from real estate debt investments. For investors seeking regular income, this can be a significant advantage over growth-focused investments that may not provide immediate cash flow.
- Tax advantages: Real estate investing of all types can offer significant tax benefits. Specific tax benefits may include depreciation deductions, passive loss deductions, 1031 Exchange eligibility, and capital gains tax deferral. For example, the depreciation deduction allows investors to write off the cost of income-producing property over its useful life, potentially reducing taxable income. The 1031 Exchange allows investors to defer capital gains taxes by reinvesting proceeds from a property sale into a like-kind property.
- Appreciation: Steady growth in rental income and asset value is another advantage of real estate as an alternative investment. Rent and sales prices can be adjusted to create more income as inflation and market demand increase. Over the long term, real estate has historically appreciated in value, outpacing inflation in many markets. This potential for both income growth and capital appreciation can make real estate a powerful wealth-building tool.
Concerns with Alternative Real Estate Investments
While alternative real estate investments offer numerous benefits, they also come with some potential drawbacks that investors should carefully consider:
- Lacking liquidity: Unlike stocks and bonds, lumpy assets like alternative real estate investments can be challenging to sell quickly due to the absence of a singular secondary market. This illiquidity can be problematic if you need to access your capital quickly or want to rebalance your portfolio in response to changing market conditions.
- Low control: In cases where investments are professionally managed, people who desire more control over management might find the hands-off approach undesirable. For example, if you invest in a REIT or a real estate fund, you're entrusting your capital to the fund managers and have little say in day-to-day operations or investment decisions. This can be frustrating for investors who prefer a more active role in managing their investments.
- Scam risks: Alternative investments often have less regulatory oversight compared to traditional assets. While this could be beneficial in some cases, it can also make them more susceptible to scams or fraud. The relative lack of regulation in alternative investments can increase the risk of fraudulent schemes.
- Higher fees: Many alternative real estate investments come with higher fees compared to traditional investments. For instance, private equity real estate funds often charge management fees and performance fees, which can eat into your returns.
- Complexity: Alternative real estate investments can be more complex than traditional investments, requiring a deeper understanding of real estate markets, financing structures, and legal considerations. This complexity can make it challenging for some investors to fully grasp the risks and potential returns of their investments.
- Valuation challenges: Unlike publicly traded stocks, which have readily available price quotes, alternative real estate investments can be difficult to value accurately. This can make it challenging to assess the true performance of your investments and can potentially lead to surprises when it comes time to sell or liquidate your position.
8 Types of Alternative Real Estate Investments
Let's explore some of the most popular types of alternative real estate investments:
1. Real estate partnerships
A partnership is a joint venture that involves two or more real estate investors combining resources such as property, cash, expertise, or effort to work towards a shared goal. This collaboration allows for risk-sharing, distributed responsibilities, and improved potential outcomes. Partnerships can be an effective way to pool resources and expertise, enabling investors to take on larger or more complex projects than they could manage individually.
2. Real estate impact investing
Impact investing aims for financial returns alongside positive social and environmental impacts. When it comes to real estate, this may include:
- Green real estate: Implementing sustainable practices to exceed current building standards in energy and water efficiency, waste reduction, and safe housing.
- Affordable housing: Providing housing for underserved populations.
- Sustainable community development: Creating projects that support community growth.
Impact investing allows investors to align their portfolios with their values while still seeking competitive returns.
3. Hard money loans
These refer to short-term loans issued by individual investors or companies for property renovation. These loans are based on the property's "after repair value" (ARV) rather than the borrower's creditworthiness, with the property serving as collateral. Hard money loans can offer high returns but also come with higher risks, as they're often used to finance projects that traditional lenders won't touch.
4. Real estate investment trusts (REITs)
REITs are companies that manage a portfolio of real estate investments. They are passive investments, allowing you to generate income from properties without owning them directly. Some REITs are publicly traded on the New York Stock Exchange, focusing on commercial properties like malls, offices, and hospitals, while others are private and may be restricted to accredited investors, providing options for various investor types interested in the commercial real estate market.
5. Residential real estate
This is the most common type of real estate investment, including long-term rentals, vacation rentals, house flipping, and accessory dwelling units (ADUs). Residential investments can be labor and capital intensive, but can yield substantial profits and continuous cash flow. For more information on getting started with residential real estate investing, check out this guide on buying a rental property.
6. Commercial real estate
Involves investing in non-residential properties such as hotels, warehouses, office buildings, and retail stores. Investors earn by renting out the space to businesses or selling the property as its value appreciates, similar to residential real estate but typically on a larger scale. Commercial real estate can offer higher potential returns than residential properties, but often comes with higher risks and requires more specialized knowledge.
7. Real estate crowdfunding platforms
A method where investors pool funds online to participate in real estate investment opportunities they couldn't finance individually, democratizing access to larger projects. Like REITs, it requires less upfront money and provides passive income. Some real estate crowdfunding websites are open to general investors, while others require proof of a certain income level before investing. This democratization of real estate investing has opened up new opportunities for smaller investors to participate in large-scale real estate projects.
8. Land investments
This refers to purchasing land for commercial or residential development. This type of investment requires significant market research and is best suited for those with substantial capital and extensive real estate knowledge. If you lack these resources or expertise, consider alternatives like REITs or real estate crowdfunding to invest in land. Land investments can offer high potential returns, especially if you can identify areas poised for growth, but they also come with unique challenges such as zoning issues and development costs.
Ready to Invest? Do It Right With Kubera
Investing in real estate requires a clear understanding of your financial health and investment goals. As you venture into the world of alternative real estate investments, it's crucial to have a comprehensive view of your overall financial picture.
Kubera is an all-in-one financial dashboard that provides the insights you need into your net worth, asset allocation, and portfolio performance. This powerful tool can help you make informed decisions about your alternative real estate investments by putting them in the context of your broader financial situation.
Connect your bank accounts, investment portfolios, and real estate assets to get a holistic view of your finances. This enables you to choose the best real estate investments and how much of your net worth to allocate to real estate. Understanding the right percentage of your net worth to invest in real estate is crucial for maintaining a balanced and diversified portfolio.
With Kubera, you can:
- Track the performance of your alternative real estate investments alongside your traditional investments
- Keep tabs on the changing value of your real estate assets, or REITs in addition to other assets you own
- Analyze your overall portfolio allocation to ensure you're maintaining your desired level of diversification
- Simulate and model future financial scenarios accurately to make better investment decisions
By providing a clear, comprehensive view of your finances, Kubera empowers you to make strategic decisions about your alternative real estate investments. Whether you're just starting out or looking to optimize your existing portfolio, Kubera can provide the insights you need to invest with confidence.
Sign up for Kubera today and start building a profitable real estate portfolio. With the right tools and information at your fingertips, you'll be well-equipped to navigate the exciting world of alternative real estate investments.
Remember, while alternative real estate investments can offer attractive benefits, they also come with unique risks and challenges. Always conduct thorough due diligence, consider seeking advice from financial professionals, and never invest more than you can afford to lose.
With careful planning and informed decision-making, alternative real estate investments can be a valuable addition to your investment strategy, potentially providing steady income, tax benefits, and long-term appreciation.
