5 January 2018
Real estate: The key is diversification!
Given the current exceptionally low interest rate environment in which we live and the rather volatile state of the markets, many people are considering investing in real estate.
Unlike an investment in the financial markets, investing in real estate seems simpler and more accessible to the average Belgian and their love of “bricks and mortar”.
Bricks and mortar and "paper bricks and mortar"
Choosing to invest in bricks and mortar means investing in something tangible, something we are familiar with and therefore something reassuring. Those who make this choice think back to the attractive returns of investments made by older generations in recent decades.
However, investing in real estate can also be done indirectly through financial instruments. This is referred to as investing in "paper bricks and mortar". This category mainly consists of real estate funds and Regulated Real Estate Companies (RREC), formerly known as "SICAFI".
"Paper Bricks and Mortar": real estate funds and RRECs
No need for a solid budget, real estate funds pave the way, for a very limited amount, to a diversified real estate portfolio (international or European), actively managed by professionals. These funds invest in real estate companies that rent, manage, develop, buy and sell offices, residential property, shopping centres, logistics centres, nursing homes, hotels, etc. Fund managers are also attentive to portfolio diversification, both in terms of sectors and regions.
RRECs generally invest in property: either in business premises, office space, warehouses, rest homes or residential buildings. While they remain less diversified than real estate funds, RRECs can invest up to 20% of their capital in the same building. In addition, they can borrow 65% of the value of their portfolio and must distribute 80% of their earnings in the form of dividends. In both cases, the investor benefits from access to a more diversified real estate stock, but also from the advantages related to economies of scale resulting from the professional management of the portfolio (for example maintenance weighs less heavily on performance than in the case of a private investment) and the financial leverage capacity of the fund or the RREC (which are financed at a lower cost compared to the private investor, because of the diversification of their sources of financing).
It is important for private investors to realise that investing in this type of product is not the same as investing in residential real estate. In other words, this product cannot be seen as a hedge while waiting for the purchase of a house, for example.
Bricks and mortar vs. "paper bricks and mortar": the main advantages and disadvantages
Follow the link below for a comparison table outlining the advantages and disadvantages of investing in a property, a RREC or a real estate fund:
Risks associated with real estate investmentsA real estate investment must always be conceived as a diversification based on a personal investment profile
Investing in real estate, whether it be directly or through "paper bricks and mortar", is not without risk. Vacancy risk, non-payment by a tenant, loss (fire, storm, water damage, etc.), degradation of a building (related to wear, deterioration or obsolescence of a property in the face of new legal requirements, etc.), the impact of a rise in interest rates or a legislative change are all risks that must be taken into account when opting for a real estate investment.
Moreover, while residential real estate enjoyed a nominal growth of 115% in the decade preceding 2008, according to experts, growth rates in the current decade for the same sector look set to be limited to one-tenth of that, an average growth lower than inflation. It would therefore appear that past performance in no way guarantees future performance.
The impact of a rate hike (which one day hopefully should happen), would also be felt. According to our experts, any rate increase of 1% would result in a 9% rise in monthly mortgage loan payments for the same amount borrowed over 20 years. The prospective buyer would therefore have to either inject more capital or find a much cheaper property. In such a context, a rise in interest rates would quickly lower the prospects for capital gains for private investors who would find themselves faced with a real estate market that is more difficult or even embarked on a sustainable downward path.
In conclusion, a real estate investment must always be conceived as a diversification based on a personal investment profile, taking into account a person’s overall assets. Due consideration must be given to the weight of your own home in your portfolio before investing more in this asset class. Indeed, many Belgians are overweighting this asset class in their overall estate.
In this perspective, and to ensure that a new investment in real estate does not unbalance your portfolio, expanding this type of investment to different sectors (hotels, commercial leases, industrial ...) may be more cautious and judicious.