In its original form, Modern Portfolio Theory (MPT) was a mix between stocks and bonds, usually a 60/40 split. As the theory evolved, other types of investments were added, and one of the first was real estate.
Traditionally, holding real estate investments in your wealth portfolio might have meant owning rental property or investing in real estate investment trusts (REITs). But today, we have many more options. Here are some of the ways you can include real estate in your portfolio.
A Delaware Statutory Trust (DST) is a way for individual investors to pursue the benefits of investing in professionally managed commercial real estate with an investment cost that is typically lower than direct property ownership.
A DST is a real estate ownership structure under which multiple investors hold a fractional interest in the trust’s holdings. The trust is established by a DST Sponsor, a professional real estate company that identifies and buys the real estate assets.
As individuals invest, their investments displace the money used by the DST Sponsor to buy the property until its entirely owned by the investors. Investors own a beneficial interest in the trust. As such, investors hold a percentage of the ownership, and no one owner can claim exclusive ownership over any specific aspect of the real estate.
Potential DST Pros
One of the benefits of a DST is that it qualifies as a “like-kind” real estate for a 1031 exchange, which allows investors to defer capital gains taxes when selling an investment property. Investors can use the proceeds from the sale of their investment property to purchase a fractional interest in professionally managed real estate.
DSTs are a hands-off way to invest in real estate in the sense that there are no tenants to manage, no repairs to make, and no evictions to process for the investors who hold a fractional interest in the DST. They’re also a potential source of passive income.
DSTs make investing in commercial real estate accessible to small investors with minimums sometimes as low as $25,000.
Potential DST Cons
DSTs come with many of the same risks as any other real estate investments: extended vacancies, damage from natural disasters, market conditions, interest rates, and other factors that are often out of the investor’s control. But perhaps the biggest consideration when evaluating DSTs is keeping in mind that DSTs are an illiquid investment. Investors should understand that they need to hold their investment in a DST 1031 property for the full life of the program, which could be seven to ten years and longer in some cases. If an investor needs immediate access to cash, the illiquid nature of DSTs would make that difficult.
Ways to Invest in a DST
Accredited investors can buy an interest in a DST through a broker-dealer and DST sponsor. DSTs can be used as a like-kind property during a 1031 exchange, or investors also have the ability to make a direct cash investment.
Qualified Opportunity Funds (QOF) are investing vehicles created to encourage real estate or business development investments in areas deemed Opportunity Zones (OZs) or Qualified Opportunity Zones (QOZs). There are almost 9,000 Opportunity Zones in the U.S. and U.S. Territories.
Potential QOZ Pros
To encourage investments in opportunity zones, the government offers several tax incentives. Any person who has capital gains can qualify:
Potential QOZ Cons
QOFs were only created in 2017, so a very young and, therefore, an unproven investment vehicle. QOFs have different requirements: some are only open to accredited investors, and some have high minimums that may price out some investors.
Ways to Invest in a QOZ
A list of investment opportunities is available to investors from the National Council of State and Housing Agencies (NCSHA) Opportunity Zone Fund Directory. You can filter the funds by fund name, size, geographic focus, or investment focus.
Raw land is property that hasn’t had any improvements like water, sewage, or electricity installed.
Potential Pros to Investing in Raw Land
Raw land is a tangible asset, and owners can use it for storage or various types of recreation, depending on the location. Raw land can be less susceptible to financial impact from natural disasters (hurricanes, floods, fires, etc.) than other forms of real estate, and little to no maintenance is required for raw land.
Land can act as a hedge against inflation when held over a long period and it is generally not correlated with the stock market, so it can provide a form of diversification in a portfolio.
Potential Raw Land Cons
Lenders will often consider loans for raw land risky as the land isn’t ready or suitable for development, and the potential buyer doesn’t have any plans for it. Because of this, a large down payment may be required, up to 50%. Additionally, raw land produces no income as there are no tenants.
Potential development for raw land is governed by zoning laws, something you can’t control and that can change. If you plan to develop the land eventually, you must deal with whatever permits are required, something that can be costly and involve a lot of red tape.
If your property is landlocked, you will need to secure easement rights from neighboring property owners to access it.
Ways to Invest in Raw Land
Several sites specialize in listing land for sale. Investors can find additional details and steps if they decide this is an option for their portfolio:
Co-working spaces rent office space to employees of different companies, small businesses owners, and freelancers. The offices supply equipment, supplies, utilities, receptionists, cleaning staff, and more to provide a turnkey working environment.
Potential Co-Working Space Pros
Arguably, one of the biggest questions when it comes to commercial real estate investing is how office spaces will fare during the pandemic. Even if most companies are operating in a hybrid or work-from-home environment, that doesn’t mean there is no need for office space; some jobs require being onsite and some employees enjoy having the option of going into an office.
Co-working spaces fit the need nicely for companies who need some office space but not nearly as much as before. Co-working spaces are also popping up in Opportunity Zones, which can provide additional tax incentives.
Potential Cons to Investing in Co-Working Space
These spaces are often rented by small start-ups and individuals running small businesses. As such, the turnover rate for these tenants may be higher than investing in a more traditional office space setting.
Ways to Invest In Co-Working Spaces
There are REIT options that include co-working spaces in their portfolios. There are co-working franchises available for investors.
Potential Pros of Retail Space
Retail leases are typically multi-year, which is longer than residential leases, so you have less tenant turnover. Some retail space is very versatile and is suitable or can easily be modified for a wide variety of business types.
Potential Cons of Retail Space
Retail businesses, and therefore their spaces, are sensitive to economic conditions. When there is a downturn, there is less demand for some of the products or services these businesses may provide. While there is less tenant turnover compared to multifamily or student housing, finding retail tenets is more challenging for retail space than for residential space.
Ways to Invest in Retail Space
REITs are the easiest way to invest in retail and other forms of commercial property. And you can invest in multiple REITs through a REIT ETF.
Real estate provides several investment opportunities as an asset class, which can help investors as they are building out a portfolio that seeks to follow the outline in Modern Portfolio Theory. It’s recommended to consult an investment professional when determining what investments are suitable for you based on your specific needs and investment goals.