A common reason that investors flock from the stock market is volatility. And the fall of 2022 was no different as many stock market investors are finding their portfolios down about 20% year to date. What is more unfortunate, these investors will have to see 40% or more growth in market performance just to break even in today’s dollars.
And, with record inflation and a looming recession, there does not seem to be a recovery in sight.
So, for those investors who no longer want to ride the Wall Street rollercoaster, what other asset classes offer options to make a solid return and ditch volatility?
Well, cash is losing right now at ~7.75% annually. Metals are down one to two percent for the year. And cryptocurrencies like Bitcoin, once touted as being “digital gold” poised to hedge inflation, have seen a fantastical collapse at 64.8% (as of December 7, 2022, according to the cryptoeconomy website Messari.io).
Then there is real estate.
Though real estate is not immune to market cycles, there are many reasons why real estate is a solid asset class that weathers market volatility well.
Why Real Estate is Less Volatile
First, real estate moves over years, not days, hours, and minutes like the stock market. While having liquidity at a moment’s notice might feel more comfortable to any investor, the illiquidity of real estate can work in an investor’s favor. First, it can save you from yourself since you can no longer panic sell as you can with the stock market. Second, the illiquidity of real estate also insulates you from other investors’ actions since these assets are not subject to panic selling.
Second, unlike the global stock markets, real estate is very local. For example, the technology industry trends up or down regardless of which coast you are on. However, the multifamily market in California trends and cycles independently of the multifamily market in the Carolinas. Therefore, as an investor, you can research and invest in the best growth market with distinct market drivers. Some growth market drivers to pay attention to are population growth, job growth, income growth, supply/demand growth, job diversity, crime, and poverty decline.
Third, capital preservation. Real estate is a hard asset where the land has value (so it cannot collapse to zero). The valuation is a calculation of the net operating income (commercial real estate), and it is essential and finite. Also, you can visualize reserves and comparable assets easily. The stock market can collapse to zero, is non-essential, and is not finite. Moreover, the value of the stock market is driven by supply and demand (not valuations, as many investors think).
Last, when you invest in the stock market, you have limited ways to grow your wealth since you largely benefit from appreciation and a small amount of cash flow (it is possible to get small tax benefits if you invest in municipal bonds or tax loss harvesting). However, when you invest in real estate, you can take advantage of multiple pillars of wealth generation.
1. Cash Flow – Real estate produces income through regular rent collection.
2. Equity Growth – Real estate produces equity through natural market appreciation, forced equity business plans, and potential tenant paydown of the outsourced loan.
3. Tax Benefits – Real estate has pass-through tax benefits such as depreciation, accelerated depreciation, bonus depreciation, and the 1031 exchange. Unless you invest in municipal bonds, all tax benefits in the stock market are maintained at the corporate level. What is worse is you, as the investor must pay capital gains if you want to benefit from your portfolio and sell your shares.
4. Smart Use of Leverage – You can take out a loan to purchase real estate, borrowing up to 80% of the loan to the value of the asset. Not only does this allow you to increase your returns, but you can also diversify your equity exposure in any one asset. While you can achieve great diversification in the stock market across companies, you cannot get a bank loan to invest in the stock market (that should tell an investor something right there!).
While real estate is not immune to market cycles, when it comes to reduced volatility and making more millionaires and billionaires, nothing (not even Wall Street) can beat it.