Investors today, in our opinion, can utilize four main Modern Traditional investments and four main Modern Alternative (ALTs) investments to more effectively structure their portfolio. We plan to address each of these assets in coming weeks. Today we’ll take on only one asset, direct participation real estate (DPRE).
The different kinds of real estate get grossly misdescribed and miscommunicated by the popular media because they tend to lump all real estate together. However, different kinds of real estate have different cash flows, costs, risks, potential benefits and are most definitely owned in a different way. Today’s discussion of DPRE will distinguish it from other kinds of real estate and help accredited investors decide whether DPRE might suit their interests. We think DPRE is a timely topic partly because of a recent Marcus & Millichap report:
Minneapolis-St. Paul placed #1 in the nation in Marcus & Millichap’s 2019 Multifamily Investment Forecast.[i]No other Midwest city ranks even in the top 20.[ii]This forecast projects economic factors and demand & supply for multifamily dwellings in 46 major markets. This top ranking means no other market in the U.S. and Canada offers a more favorable forecast for multifamily dwelling investment opportunity than the Minneapolis-St. Paul metropolitan area. Demographic trends, economic vitality, and a decline in homebuying partly explain the #1 rank.
DPRE is not:
- the housing market
- a real estate investment trust (REIT)
- single or duplex rental units
- fix-and-flip assets
Rather, a single DPRE investment represents ownership in a specific multi-unit property. It can be a senior living community, an apartment complex, or a commercial property, to name a few. DPREs enable investors to optimize preference for location and market. Commercial real estate naturally creates depreciation. Unlike REITs and other financial assets, DPRE properties pass through depreciation and interest expense to investors, offering potential tax-deductions.[iii]
Here are three factors that can help accredited investors decide whether DPREs might suit their interests[iv]:
You favor a diversified investment portfolio characterized by assets whose returns have low or no correlation.[v]Consider this graph:
This illustration plots the historical investment value of the S&P 500 Index and a REIT index through the Great Recession and well into the recovery. The important thing here is not which investment performed better. Rather, notice how the two hypothetical investments, indexes of domestic stocks and REITs, move in tandem. The correlation is about +.82. This history makes it difficult to argue in favor of REITs as a useful source of diversification. DPRE, on the other hand, is non-correlated with stocks and many other asset classes. Therefore, DPRE should deliver a useful source of diversification to a portfolio.
- You see how a rushing confluence of social, demographic, and economic trends can present potential opportunity:
- You favor investing in businesses that can create high-paying local jobs and serve the needs of local communities.
Consider the difference between Modern Traditional assets and the old traditional ones: DPRE is an example of a Modern Traditional asset. It offers potential for income, growth, wealth preservation, and diversification. The old traditional ones include ownership in shares of mutual funds, variable annuities, REITS, and other packaged products. Although traditional investments might be suitable for some investors, we believe they lack the potential of Modern Traditional assets. Horses didn’t become obsolete because they were useless. Rather, new innovations came along; the same is true of investment vehicles.
[i]Marcus & Millichap, 2019 Multifamily North American Forecast. Retrieved from https://www.marcusmillichap.com/research/researchreports/reports/2019/01/28/special-report-multifamily-investment-forecast-2019.
[iii]We are not tax experts, and we encourage investors to consult a tax adviser.
[iv]For the complete list of factors contact firstname.lastname@example.org text dpre to 555888.
[v]For a quick review of correlation and diversification, see https://www.financialfortitude.com/fortitude-nation-news/correlation-revisited/.
[vi]Centers for Disease Control, retrieved 19 Dec 2018 https://www.cdc.gov/nchs/data/nvsr/nvsr67/nvsr67_08-508.pdf.
[vii]Wan He, Daniel Goodkind, and Paul Kowal U.S. Census Bureau, International Population Reports, P95/16-1, An Aging World: 2015, U.S. Government Publishing Office, Washington, DC, 2016.
[viii]March 2015 Housing and Urban Development report retrieved 20 Dec 2018 https://endhomelessness.org/new-hud-report-shows-trends-of-homelessness
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