One of the first things you hear when you're building your investment portfolio is that you should spread your wealth across different types of investments. That means you should diversify your holdings. You can build your portfolio on your own or with the help of an advisor who may help you choose a combination of stocks, bonds, and other securities. You may also want to consider investing in real estate. But before you dive in, there are a few things you may want to consider. What kinds of real estate investments should you choose? And what are the average annual returns in long-term real estate investing? Read on to find out more about this sector and how far your dollar will go when you invest.

Key Takeaways

  • Real estate investments can come in a variety of forms.
  • The real estate sector is divided into two main categories—residential and commercial real estate.
  • One way to diversify your real estate holdings is by investing in real estate investment trusts.
  • There are also mutual funds and exchange-traded funds available that track the real estate sector.
  • Private commercial properties returned almost as much as the S&P 500 over a 25-year period as of March 30, 2019.

Investing in the Real Estate Sector

Real estate investing can be a very challenging experience but it can also be very rewarding. It takes some experience, not to mention a lot of patience, time, and money. After all, you can't just invest your money and expect to start profiting immediately.

Investments in the real estate sector can take many different forms including:

  • Investment properties including residential, commercial, retail, industrial, and mixed-use properties
  • Real estate investment trusts (REITs)
  • Real estate-related company stocks
  • Mutual funds
  • Exchange-traded funds (ETFs)
  • Tax lien certificates

The average annual returns in long-term real estate investing vary based on a number of factors—by the area of concentration in the sector. According to the National Council of Real Estate Investment Fiduciaries (NCREIF), the average 25-year return for private commercial real estate properties held for investment purposes slightly underperformed the S&P 500 Index as of the organization's May 9, 2019, report at 9.4%. The report factored in figures as of the end of March 2019. Residential and diversified real estate investments do a bit better, averaging 10.5%. Meanwhile, real estate investment trusts (REITS) tied with an average annual return of 10.5%.

S&P 500 Index

The S&P 500 Index's average annual return over the past two decades is approximately 9.8%. By any measurement, the real estate sector has done just as well as the overall market, even factoring in the drastic collapse in housing prices during the 2008 financial crisis.

The real estate sector is divided into two main categories—residential and commercial real estate. Within either category, there are vast and varied opportunities for investors, such as raw land, individual homes, apartment buildings, and large commercial office buildings or shopping complexes. Investors can choose to invest directly in residential or commercial real estate or invest in real estate company stocks or bonds. There are also mutual funds and exchange-traded funds (ETFs) available that track the real estate sector.

Diversification

One way investors can easily obtain diversification in real estate investments is by investing in one of the best-performing real estate investment instruments—REITs. REITs are securities that trade on an exchange, just like regular stocks. REITs may be invested in properties, real estate or property management companies, mortgages, or any combination of these. They are specially regulated and offer tax benefits and investment advantages, such as dividend reinvestment plans (DRIPs). REITs have established a reputation for offering investors liquidity, diversification, and good overall investment returns.

Don't discount REITs as an investment choice—they provide liquidity, diversification, and good returns.

Investors can invest directly by buying shares of REITs or obtain access to them through real estate sector mutual funds or ETFs that have major portfolio holdings of REITs.

Advisor Insight

Mark Struthers, CFA, CFP®
Sona Financial, LLC, Minneapolis, MN

While real estate certainly can be part of a portfolio, it may not provide the returns most people come to expect. In most cases, research shows that you'll be lucky to keep pace with inflation when it comes to your primary home. I would offer a word of caution. We have been in a low rate environment for a long time. Real estate often pays a high dividend. If the return came from higher than normal cash flow—if rates were to rise—the value may fall.

Investing in REITs is a great way to gain exposure to real estate. But just know what you’re buying. Private placement REITs are layered with fees and conflicts of interest. Understand what you are buying with publicly-traded REITs, too. For instance, consider whether they own a lot of mall properties that are going through a secular change as more people shop online.