Real Estate as a Diversifier — It’s Not Just a Private Matter

If you are someone that follows their stock investments religiously, at best you likely experienced some late summer stress or at worst triggered flashbacks to the 2008 market crash. Many RECF platforms sensed an opportunity, and bombarded the media in an attempt to pull the fund outflows from the stock market into the safe haven of private real estate.

Proponents of real estate crowdfunding have gone a step further, arguing that private real estate investment offers the only true diversification from stock market volatility, presenting recent articlesthat point to the “correlation coefficient” on private real estate vs public REITs. In addition, they argue that private real estate does not exhibit the same volatility of public REITs.

In my view, these arguments are based on flawed data and very selective bias. In the short term, they are correct. But for the lock up periods that these investments require, there is no material diversification benefit. For the non-accredited investor, REITs remain the more suitable investment.

Warren Buffett Never Worries About Volatility

In comparison with private real estate, publicly traded REITs have had higher returns over long periods. However, many investors seem to favor private real estate because of its perceived lower volatility. Since REITs and private real estate both involve ownership of underlying commercial properties, the cycles of the two investment vehicles should theoretically be similar. A lot of this difference in volatility can be explained by the way in which are valued. The value of a REIT reflects the consensus forward view of a particular company’s (or the properties they own) prospects. Those consensus views may change daily, but minute by minute fluctuations in price are likely caused by the flow of equity funds in the market. Until a property is ultimately sold, the value of an individual asset is determined by an appraisal which relies heavily on prior sales transactions. This method of valuation is backward looking, underestimates the riskiness of the real estate asset class, and distorts its correlation with the total return of other assets. Over a full real estate cycle, many of the vehicle-specific effects of REITs and private real estate cancel out as their returns reflect the same common drivers. Warren Buffett is famous for saying the best time to sell a stock is never. The longer you hold, the less concerned you are with market fluctuations.

Be Careful What You Wish For

In a recent — and famous among the RECF community — episode of “Shark Tank”, a poor sap representing an emerging platform named Tycoon Real Estate gave his pitch to an unforgiving panel of Sharks. Robert Herjavec, in his polite Canadian manner, expressed concern with the lack of liquidity in real estate crowdfunding investments. Kevin O’Leary said that he could get the same benefits by investing in a REIT, which he can sell at any time.

It is true, real estate crowdfunding does not offer liquidity although some are attempting to address this issue. Technically any asset can be sold, it’s just a question of the depth of demand and the obstacles to transact. The more limited the market and more obstacles to transact, the greater the “bid/ask” spread. Don’t hold your breath hoping you’ll be made whole on your crowdfunding investment if you wish to exit early, however.

The trade off, or at least the perceived problem with enhanced liquidity, is the “mark to market” knowledge that comes with it. Ultimately the only price that matters is the one you exit the investment at. If you plan to hold the REIT stock for the same length of time as a real estate crowdfunding investment (between 5–7 years) the anecdote for volatility is simple — don’t pay attention to the price until it’s time to sell.

Jockey or the Horse?

Aside from the liquidity considerations, the other major difference between a REIT and a private real estate crowdfunding investment really depends on the value you place in the management. With a few exceptions, an investment in a REIT is a bet on a particular property type and the management’s ability to source strong investments. For that expertise, you are paying a premium through higher management fees. Alternatively, a real estate crowdfunding investment is a bet on an individual property. You decide if that investment is a good one, not the management (who have already committed to the purchase). You have to perform your own due diligence and determine if the returns are appropriate.


The primary founder of Vrytas and the creator of the V-Score™ model brings over 20 years of real estate investment experience, primarily in debt syndication and commercial mortgage securitization with bulge bracket firms on Wall Street. He has placed securities in all aspects of the capital stack, from equity to mezzanine and first mortgages, to insurance companies, domestic and european banks, and hedge funds.

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