Do you have enough real estate in your portfolio?

04 November 2018 by National Bank

Impressive price gains in residential markets have received plenty of attention. But for high-net-worth investors, real estate can also provide valuable diversification.

In recent years, real estate has become a hot topic of conversation at dinner parties and office lunchrooms across Canada. The dramatic increase in house prices in residential markets like Toronto and Vancouver has led to sizeable “paper gains” for many homeowners. As well, real estate has proven to be an effective part of the portfolio mix for many high-net-worth investors. But what is the best way to invest in real estate – and how much is too much in an overall portfolio?

While the impressive price gains in residential markets have received plenty of attention, real estate’s biggest value is not as a high-return investment, but as diversification, says Martin Lefebvre, vice-president, chief Investment officer and strategist at National Bank Private Banking 1859.

Investments rising and falling at the same time

Most investors have observed that, more than ever, investments are rising and falling at the same time, explains Mr. Lefebvre. Whether it’s U.S. Treasury bonds, a Canadian bank stock, a barrel of oil or a Spanish utility, they all seem to move in the same direction. Mr. Lefebvre points out that real estate has a very low correlation to most other assets, including Canadian stocks and bonds. That low correlation means real estate can help limit a portfolio’s losses when many investments are losing value.

“In most situations, you will reap the benefits of real estate to smooth things out,” says Mr. Lefebvre.

Is there a guideline for how big a role real estate should play in an investors’ portfolio?

“Absolutely not,” says Don Campbell, founding partner and senior analyst at the Real Estate Investment Network (REIN). Headquartered in the Vancouver area, REIN provides real estate investment education, research and analysis. Mr. Campbell says an investor’s age, knowledge, source of net worth and risk tolerance all play a role in determining the portfolio percentage real estate should account for.

No rule of thumb

Mr. Lefebvre agrees there isn’t a rule of thumb when it comes to real estate investments and it depends on the investor’s risk profile. With a higher-risk portfolio, he suggests that 10 to 20 per cent of the overall amount should go to non-correlated alternative asset classes such as real estate.

There are also important differences for high-net-worth (HNW) investors, as compared to investors with more modest holdings. Mr. Lefebvre notes that while HNW investors often own more than one property for their own use, much of their net worth may be in “traditional” investments such as stocks and bonds, either directly held or through managed funds. In these cases, additional investment in the real estate asset class can be an important way to diversify an investor’s holdings.

There are several ways for HNW individuals to add to their real estate holdings. Perhaps the most straightforward approach is to simply buy individual properties directly. This includes residential real estate (houses, condos, apartment buildings), commercial and industrial properties.

These properties can then provide lease income, as well as the potential for capital appreciation. However, there are drawbacks to this approach. If the purchase includes a development plan, it can be several years before any return is realized. Liquidity can also be an issue – it may not be quick or easy to sell such investments. These properties also require maintenance and management, which reduces returns. And perhaps most importantly, there is little diversification – a large investment in a specific real estate holding can expose the investor to significant risk.

For these reasons, Mr. Lefebvre recommends investing in managed real estate funds. “Just like with equities, you want to maximize your diversification,” he says.

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