Why is it a wise decision to diversify your portfolio with commercial real estate?

By Bricksnwall | 2024-01-07

Why is it a wise decision to diversify your portfolio with commercial real estate?

The stability of fixed-income assets and the possibility of greater profits from stocks should be balanced by investors. Annual profits from commercial real estate come from the chance to take part in property appreciation as well as the rental income.

Investing portfolio diversification is a critical tactic for risk management and return optimisation. While it may seem that there are many investable asset classes accessible today and that investors have a wide range of possibilities, every conscientious investor will essentially consider these two factors when assessing a potential investment opportunity.

i) Capital protection or return (Safety FIRST)

ii) Capital return (adjusted for risk; next)

The majority of investment products fall into one of two categories: either the volatility of equities (such as direct stocks, equity mutual funds, ETFs, etc.) or the stability of fixed income (such as government securities, bank FDs, bonds, debt mutual funds, etc.).

To maximise returns on his or her portfolio, a shrewd investor should aim to combine fixed income, equity, and hybrid security investments. Astute investors will strive to strike a balance between fixed-income (debt) investments' stability and the high-risk, high-reward world of stocks.

Liquidity, or the ability to swiftly convert an investment into cash, and real returns, or investment returns evaluated against the inflation rate, are, of course, of utmost importance throughout the entire asset allocation process.

Using CRE to diversify your portfolio

Although residential real estate has historically accounted for a large portion of retail investor capital, it has historically offered very low yields (less than 4% in most cities) and returns that are insufficient to offset the inherent illiquidity of such investments. This is despite the fact that Indian investors have historically placed a high value on real estate.

I'd want to introduce commercial real estate at this point. Commercial real estate combines the qualities of debt and equity by offering 8?9% annual returns through rental yield and the chance to share in the underlying property's appreciation. 

The principle amount is also much safer because it is an actual asset. The annual rent increases related to inflation are the cherry on top. The majority of commercial leases provide a robust inflation buffer by increasing by 5% annually or 15% every three years. Because of this, the real rate of return is consistently between 8 and 9%, with the extra equity kicker coming from capital appreciation.

The credit risk of unpaid rent is minimal when real estate investments are made in appropriate institutional-grade assets occupied by prestigious tenants. An experienced real estate investor will make a tenant more difficult to move out of by having them complete the fit-outs, or TIs, and by having them sign a "lock-in," which is a contract that keeps tenants in a property for an extended period of time.

Additionally, investors can take advantage of the stable returns (which include monthly rental payouts to all investors) by reinvesting the monthly rental distributions in other assets through a systematic investment plan or using them for ongoing costs. Creating a sizable CRE investment portfolio that is diversified across asset classes, tenants, and locations (offices, warehousing, retail, etc.) also makes sense.

In conclusion, retail investors should think about include premium commercial real estate in their portfolio, even though affluent and institutional investors have always made such investments. To handle your investments (tenant management, exit strategy selection, rent collection, regulatory compliance, etc.) with efficiency.

Just as retail investors traverse the equity markets through a reputable fund house or a trustworthy fund manager, it is crucial to route CRE investments through an institutional and regulated investment platform.