Apartment Investing vs. Stock Market Investing

For those of us living within our means, our earned income is in excess of what we need for expenses to support our lifestyle. Since the excess is not needed for expenses, it becomes our savings that we hope will not only be there in the future when we need it, but will be more than what we started with. The concept is simple enough, just put that money in a safe place that is accessible at some time in the future.

But what is a safe place? I remember my mother telling me that her father never put his savings in a bank. I’ve also heard where people used to bury their money in their back yard. To them, this was a safe place where they could retrieve it at some time in the future (if the dog didn’t dig it up for their neighbor’s good fortune). We can think of many problems with this scenario, but our current times make the case even more telling. One of the primary reasons that just saving cash is a bad idea is due to inflation which lowers the value of the dollar. Without an investment to make that money grow, it actually becomes less valuable than when we started. We need to invest our money just to break even.

Lessons on what type of investments are available are typically not taught in school unless receiving one of the related finance degrees. Many professionals and high net worth individuals I’ve talked to have never invested in anything but the open market through their 401k, IRA or brokerage account. Mutual funds are very popular since it demands far less maintenance (risk mitigation) than specific company stock or bonds. But how risky is market investments, even with mutual funds? Let’s explore this a bit.

Market volatility is one way to measure market uncertainty and risk. It is a trailing indicator that tells us how often the market moves significantly, thus being unpredictable. From 1950 to 2000, the number of days when the market moved 3% or more gradually increased from 5 per decade to 27 per decade for a total of 81 days over the 50 year period. From 2000 to 2010, there were 95 days in that decade alone when the market moved 3% or more.

Previous to the recession of 2008, diversification meant investments scattered among U.S. stocks, non-U.S. stocks, high yield bonds, REITS and commodities. Post-recession, correlation among these assets has risen dramatically meaning that they might no longer be considered a good solution for diversification. Additionally, bonds that have historically provided a safe harbor against stock volatility have been at depressingly low yields.

Managers of apartment investments are less constrained and have direct impact on the value of the investment. As a result, returns are dependent more on an apartment manager’s skills than prediction of the ticker tape. Apartment investment managers also have several tools at their disposal, such as leverage and less liquid capital that allows them to deploy as required without the risk of investors bailing before their investments play out. Each apartment play is unique providing a different risk profile. Accordingly, returns from apartment investments are far less correlated to market ups and downs.

One indicator that apartments are becoming a desirable investment is the increase in allocation for them with institutional investors, such as pensions and endowments like Harvard’s $3.4 billion direct real estate investments. This shift in allocation is driven by the need for these institutions to maintain between 7-8% returns just to cover their liabilities and they can’t depend on the market for that.

The results show that apartment investing and the nature of real estate provides higher returns at the same risk level or same returns at lower risk levels than market investments. Apartment investment managers have the opportunity to proactively affect returns by directly managing risk and continuously search for opportunities. This entrepreneurial endeavor maintains an investment edge over standard market investments and provides safety during market volatility storms.

How do you diversify your portfolio with alternative investments?

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