Can real estate be a low cost way to diversify investments?

Portfolio Diversification.

Diversification is a key way to manage uncertainties and risks in your portfolio by investing in several asset classes and also in different investments within an asset class. It is a necessary tool to counter those heavy peaks and troughs in your long term investment plan. Used wisely this can help protect against uncertainties.  

A cursory search on how to diversify, whether online or with investment advisors usually throws up the same suggestions.

·       Passive investing with Index Funds: Mutual funds, ETFs, essentially any funds that track broad indexes like the S&P 500

·       Cash: Provides liquidity and protection in difficult situations and especially good to have in high interest rate environments

·       Stocks & Bonds: A healthy ratio of stocks to bonds as per your risk profile

·       Think Global: Regional markets do not offer the same returns in an increasingly globalised world. For example most emerging markets are growing faster and may not suffer as much in an economic slowdown.

All these are good strategies worth considering for any individual investor with a healthy portfolio. However there is one asset class that almost always overlooked as a tool to diversify:

Real Estate.

Unfortunately buying and selling properties is not nearly as easy as buying & selling stocks and bonds. For most people buying into real estate means looking for a primary home where they are resident and which also grows in value over their lifetime. It also suggests a mental picture of an arduously long process of searching for the perfect home to live in or to buy-to-let, a painful mortgage lending process and a legal process to purchase this property. This comes with a hope that other intangible factors like area, available facilities, sense of security etc. will ultimately contribute to house prices going up in value where the property is located and they will make a deeply positive return on investment in the future.

Invariably buying into real estate in this way means allocating a large part of your investment portfolio into this asset class with a strong deposit and/or healthy lending capacity. In that sense this is almost antithesis to the concept of portfolio diversification that we discussed earlier and the benefits that come with it.

Could there be another option available to take a view on the real estate asset market without allocating large portions of your portfolio to physical properties? 

Real estate derivative

A property derivative is a financial structure that allows investors to gain exposure to the real estate asset class without having to actually own property. Instead they replace the physical property with the performance of a real estate index that tracks the real estate market i.e. the buying and selling prices of all real estate in a region are mapped on an index which then represents the state of that market. An investor then buys into the state of the entire market by buying into the index rather than buying a single physical property in that region. Although investing in the index can be difficult or confusing to grasp at first, consider other examples of index investing like an ETF tracking a broad index of tech stocks. These two are not the same but it gives a general idea that investing doesn’t have to be directly in an asset class, but instead there are indirect ways to gain exposure.

However here the challenge is whether the real estate derivative can be as easily bought and sold as an ETF by everyone and that too in small enough sizes to suit them. This also goes back to the original question about portfolio diversification. Potentially the form in which real estate derivatives are used today targets a sophisticated investor base and may not be used as a general tool for diversification for every portfolio.

Could there be another easier option available to offer real estate derivatives as part of a diverse portfolio?

(Rise of the synths)

Synthetic asset protocol for Real Estate:

Synthetic assets are a new asset class made possible by blockchain technology. With the arrival of on-chain data and on-chain protocols, now there is a way to represent information regarding the real estate market synthetically. What this means is that a derivative on the real estate asset class is being simulated over the blockchain. There are many advantages to this, firstly and most obviously as stated above, using a derivative means this is an indirect means to gain exposure to real estate without buying physical property. Secondly, bringing this real estate market data over a blockchain, can make the process of investing in this asset class much more seamless and transparent. And most importantly it offers every investor a way to allocate any size of investment that they are comfortable with - starting from as little as $1. This offers a much simpler way to invest in the property market.

In summary, going back to the original question posed in this article, ‘Can real estate be a low cost way to diversify investments?’

The answer is that for the average investor it was not always possible to add real estate to a diversified portfolio without making a significant or over-sized allocation to this asset class. But today it is absolutely possible with a synthetic on-chain offering such as Real Index. 

If you are intrigued by this opportunity, stay tuned. Next time we will explain synthetic asset protocol in detail and how you can invest using it. 

‍