Should I Invest in Property?

Houses are the primary store of wealth for millions of Americans.

The question of whether to put money in property interests many investors. Generally speaking, portfolio investors should include property as one of the asset classes in their portfolio. The main reason is not based on property generating a higher return. It is also not based on property, by itself, having lower risk. Nor is it based on an investor having greater control over a property investment. The main reason is diversification.

Diversification

Diversification is one of the most basic principles of investment. Some people think that diversification is simply a matter of having a basket of investments so that if one goes down some of the others are nevertheless likely to go up. Well, that is just part of the story. The real reason is risk. Diversification highlights that a well constructed portfolio can earn the same return as an undiversified portfolio and, importantly, it can do so with lower risk.

Asset Prices Don't All Move Together

Diversification relies on the observation that not all asset prices move up and down together. In statistical terms, asset returns can be uncorrelated. Property returns can remain positive and high even when the return from investing in other assets is negative. This is because property prices can continue rising even when, say, stock market prices, government bond prices, company debenture prices or the prices of alternative investments -- like infrastructure assets -- are falling.

All Investments Have Risk

All investments have risk. But if investments are combined wisely, the collective risk of the basket, or portfolio, of investments can be less than the sum of the risk of the individual investments. That lower risk is the real benefit of diversification.

Portfolio Weighting

The returns from property investments are generally considered to be higher than those on government and company bonds but lower than those generated by domestic and overseas stock market investments.

The proportion of an investment portfolio allocated to property will reflect the risk appetite of the investor. A property weighting of between 10 to 30 percent is not unusual for a diversified investment portfolio. Risk-tolerant investors have a lower property weighting than risk-averse investors. This is because risk-tolerant investors prefer to emphasize higher-return, higher-risk investments like stocks.

Taxation

In some jurisdictions, property may have tax advantages. If so, these advantages can significantly boost the net after-tax returns generated from property and justify it having a higher weighting in a portfolio.

References

• ExcleQuant: Portfolio Theory
• "Forbes"; Four Myths about Investment Risk that Could Lose You Money; Liz Davidson; February 2011