Real estate – including private equity and private debt – is arguably one of the least risky types of alternative investments, depending on the asset class invested in.
Single-family rentals, multifamily properties, and alternative asset classes such as self-storage can generate higher yields and stable incomes within a diversified investment portfolio, while historically providing downturn protection.
The advantage of investing in an alternative asset like self-storage is that it is “under the radar screen” of the general investing public compared to residential rental property. A niche asset such as self-storage can mean less competition from other investors, along with oversized returns.
The reason that real estate is a good alternative investment in general is that it checks all of the boxes that passive income investors are looking for:
Income
Real estate investments generate recurring cash flow from rents received from tenants and dividend distributions in private equity investments.
In fact, high-quality investment real estate is often described as having “bond-like” characteristics, only better. According to J.P.Morgan Asset Management, core real estate has high quality, relatively transparent income streams that are well above core government bond yields.
Appreciation
Growth in rental rates and asset value is another reason why real estate makes a good alternative investment. In a commercial real estate investment like self-storage, leases are normally on a month-to-month basis.
This means that rents can be adjusted to match the rate of inflation and the demand for storage space in a specific market, unlike residential rental property that typically has 12-month lease agreement or other types of commercial real estate where leases of five to ten years are the norm.
Although most tenants rent self-storage space by the month, the storage unit rental duration is quite long. The average rental duration of a storage unit is about 14 months, with 42% of tenants renting for between one and ten years.
Not only does real estate have a high risk-adjusted return compared to stock and bonds, commercial real estate also acts as an inflation hedge. The Real Estate Research Institute (RERI) recently published The Role of Commercial Real Estate in a Multi-Asset Portfolio.
The report observes that commercial real estate has a positive correlation with both anticipated and unanticipated inflation, and consequently acts as a hedge against inflation. In other words, real estate values generally increase faster than the rate of inflation.
Stability
Adding an alternative investment like real estate can also create a more stable, balanced portfolio for the passive income investor.
Bond-like yields from recurring rental income, asset value growth over the long term, and the inflation hedge characteristics of commercial real estate can provide stability and act as a safe haven to investors through all phases of the economic cycle.
As RERI’s report suggests, direct investment in real estate outperforms stocks and bonds on a risk-adjusted basis for a long period of time. By including the performance of real estate in a portfolio optimization model, studies show that about 10% to 20% of a portfolio should be allocated to real estate.