In times like today, when the economic outlook is uncertain, many investors are searching for the best way to protect and steadily increase their assets. In addition to traditional financial assets such as stocks and bonds, diversification of asset portfolios, or in other words, investment diversification, has never been more important. In this context, real estate, a real asset, is gaining renewed attention as an important option for reducing overall portfolio risk and providing stable long-term returns.
This article provides a thorough explanation of the position of real estate in the investment portfolio from the perspective of an expert who, as INA & Associates, Inc. is involved in the asset building of many high-net-worth clients on a daily basis. We will provide the unique benefits of real estate investment, how it differs from other asset classes, and even how to build an effective portfolio, in layman's terms, but with expert knowledge so that the average consumer can understand it. We hope this article will help you build a wise asset portfolio.
Investment Portfolio and Real Estate Investment Basics
When you begin asset management, you are likely to hear the term "portfolio. However, surprisingly few people may have a clear understanding of its exact meaning and how it differs from "diversified investments. Here, we will organize the basic knowledge that is essential when considering real estate investment.
What is a portfolio?
A portfolio in investment refers to the specific combination of financial assets held by an investor - cash, deposits, stocks, bonds, and real estate - and their allocation ratios. It is not simply a list of assets, but should be strategically constructed based on your investment goals (e.g., retirement savings, early retirement, etc.) and risk tolerance (how much price volatility you can accept). A good portfolio is a compass for maximizing the overall value of your assets and managing risk at the same time.
Relationship to Diversified Investments
Diversification is one specific technique for building a portfolio. As exemplified by the adage "Don't put all your eggs in one basket," the objective is to reduce overall risk by investing in multiple assets with different price movements, rather than concentrating on a single asset, so that when a particular asset declines in value, the gains in other assets compensate for the impact. If a portfolio is a "composition chart of assets," then diversified investment is "the action of arranging assets based on that composition chart" itself.
Unique Characteristics of Real Estate Investment
Real estate investments have unique characteristics that differentiate them from financial assets such as stocks and bonds. While the main objective of stock investment is capital gain (profit on sale), the price of which fluctuates greatly reflecting the growth potential of a company and market trends, the main objective of real estate investment is to secure stable income gain (rental income) over the long term by renting out the property you have purchased. Of course, capital gains can also be expected from increases in property prices, but at its essence, real estate investment is more like a "business" that generates stable cash flow. This difference in nature is why real estate plays a unique role in a portfolio.
Five Strategic Benefits of Adding Real Estate to Your Portfolio
Adding real estate to a portfolio of assets has strategic implications that go beyond simply increasing the number of investments. Here are five key benefits of investing in real estate from a professional perspective.
1. Securing long-term, stable income gains
The greatest appeal of real estate investment lies in the stable monthly rental income, or income gain. Unlike dividends from stocks or distributions from mutual funds, rent is less susceptible to economic fluctuations, and once a tenant is selected, a stable income can be expected for the duration of the contract. This highly predictable cash flow is a major source of reassurance when planning for future living arrangements, and strengthens the earnings base of the overall portfolio.
2. Protection against inflation (inflation hedge)
Inflation is a risk that all investors should be wary of, as it can substantially diminish the value of cash. Real estate is an effective hedge against this inflation. In general, when prices rise, real estate asset values and rents tend to rise as well. In other words, real estate can be expected to maintain or even increase its value even as inflation reduces the relative value of other assets. This is extremely important for maintaining the purchasing power of a portfolio over the long term.
3. Middle-risk/middle-return stability
In the investment world, risk and return are inextricably linked. Real estate investments are generally positioned as middle-risk, middle-return investments. While it is rare for assets to multiply several times in a short period of time, as is the case with high-risk, high-return stock investments, it is also not almost impossible to expect returns, as is the case with low-risk, low-return deposits. Real estate prices are not as volatile on a daily basis as the stock market, and the risk of falling prices is relatively small because of its value as a real asset. This stability moderates the price fluctuation of the entire portfolio and reduces the psychological burden.
4. Tax Incentives
Real estate investment has the potential to offer a variety of tax benefits. In particular, its effectiveness as an inheritance measure is widely known. Compared to cash and securities, the inheritance tax assessed value of real estate tends to be lower than its market value, so converting assets to real estate may reduce the amount subject to inheritance tax. In addition, since expenses associated with rental management (depreciation, repair and maintenance costs, property taxes, etc.) can be recorded as expenses, it may be possible to reduce income and inhabitant tax burdens by aggregating gains and losses with other income, such as employment income. This can be a significant advantage, especially for high-income earners.
5. Accelerate asset growth through the leverage effect
Leverage (the principle of leverage) is a method of aiming for greater returns by using loans from financial institutions to invest in expensive properties that cannot be purchased with one's own funds alone. For example, if a person purchases a 50 million yen property with a 40 million yen loan added to his/her own funds of 10 million yen, he/she will enjoy the returns from the 50 million yen property. High-net-worth individuals are efficiently expanding the size of their assets by drawing down loans on favorable terms backed by their high creditworthiness and taking full advantage of this leverage effect. Of course, borrowing entails risk, but based on proper property selection and financial planning, it can be a powerful weapon to accelerate asset building.
Positioning of Real Estate in Comparison with Other Asset Classes
The key to success in building a portfolio is a proper understanding of the characteristics of each asset class and how to combine them. In this section, we compare real estate to stocks and bonds to clarify its unique positioning.
| Comparison Items | Real Estate | Stocks | Bonds |
|---|---|---|---|
| Main sources of return | Income gain (rent), capital gain | Capital gains (price appreciation), income gains (dividends) | Income gain (interest) |
| Risk/return | Middle-risk middle-return | High risk/high return | Low-risk low return |
| Price volatility | Relatively small | Large | Small |
| Liquidity (liquidity) | Low (takes time to sell) | High (can be bought and sold immediately on the market) | Relatively high |
| Resistance to inflation | Strong | Relatively strong | Weak |
| Leverage effect | Easy to utilize | Possible through margin trading, etc. | Limited |
Comparison with stocks
Stocks are attractive assets that can be expected to generate large capital gains depending on the growth potential of a company. At the same time, however, they are strongly influenced by economic conditions and market sentiment, and have the high-risk aspect of extremely large price fluctuations. Compared to equities, real estate offers stability to a portfolio because of its moderate short-term price fluctuations and the prospect of stable rental income. Since the correlation between the price movements of stocks and real estate is considered to be relatively low, combining the two can effectively diversify the overall risk of the portfolio.
Comparison with Bonds
Bonds are borrowing certificates issued by countries and companies and are considered safe assets because they are redeemed at face value if held to maturity and interest is received periodically. However, they have the disadvantage of low returns and a diminishing real value, especially during periods of inflation. Real estate offers the potential for higher returns than bonds, while at the same time providing a hedge against inflation. If bonds are the "defensive" asset in a portfolio, real estate is the "offensive/defensive" asset that can grow in value while generating stable income.
Major Risks of Real Estate Investment and Countermeasures
While real estate investment has many advantages, there are also risks. To succeed, it is essential to understand these risks in advance and take appropriate countermeasures. This section describes seven typical risks and their countermeasures.
| Types of Risks | Outline | Main Countermeasures |
|---|---|---|
| 1. Vacancy Risk | A situation in which tenants cannot be found and rental income cannot be earned. | Select an area and property with high rental demand. Set appropriate rent and conduct tenant recruitment activities. Consider sublease contracts. |
| 2. Risk of rent decline | Rent will decline due to building deterioration over time and changes in the surrounding environment. | Establish a long-term repair plan and maintain the property value. Conduct renovation and remodeling to meet tenants' needs. |
| 3. Risk of rent nonpayment | Tenants do not pay rent. | Strictly screen tenants. Require tenants to join a guarantee company. |
| 4. Interest Rate Rise Risk | Loan interest rates rise and repayment amounts increase. | Select a fixed interest rate or make early repayments. Create a financial plan with sufficient margin to anticipate interest rate rises. |
| 5. Repair Risk | Unexpected costs will arise due to repairs caused by sudden equipment failure or aging. | Plan to accumulate a reserve fund for repairs. Inspect the condition of the building on a regular basis. |
| 6. Risk of property price decline | Property values will decline due to economic recession or a drop in demand. | Select a property in a good location where property values are unlikely to decline. Assume long-term ownership and do not be swayed by short-term price fluctuations. |
| 7. Natural disaster risk | Buildings may be damaged by earthquakes, typhoons, floods, etc. | Take out fire insurance and earthquake insurance. Check hazard maps and choose an area with low disaster risk. |
Each of these risks may seem like a major threat. However, all of them can be minimized by approaching them with appropriate knowledge and preparation. Choosing a reliable real estate company as a partner and utilizing expert advice are key to managing risk.
How to Build a Real Estate Portfolio to Maximize Results
Once you have decided to incorporate real estate into your portfolio, the next step is to develop a specific strategy to maximize its effectiveness. Here we will discuss three key aspects of building an effective real estate portfolio.
1. Consider the optimal asset allocation ratio
There is no single, absolute right answer for the percentage of real estate in an overall portfolio. The ideal allocation will vary widely depending on the investor's age, asset size, risk tolerance, and investment goals. Generally speaking, it is often recommended that 10% to 40% of total assets be allocated to real estate in most foreign countries.
One way to think of it is to refer to a model portfolio such as "50% real estate, 30% securities, and 20% cash and deposits," and adjust it according to your own situation. The important thing is to determine a balanced allocation from a long-term perspective in light of your own life plan.
2. Practice diversification within real estate.
Risk diversification is an important strategy that should be practiced not only in your overall portfolio, but also within your real estate investments. Specifically, the following types of diversification may be considered
- Area diversification: Diversifying properties in different areas, such as combining properties in central Tokyo, where the population is concentrated and demand is stable, with properties in regional cities, where prices are relatively affordable and high yields can be expected, reduces region-specific risks (disasters, economic decline, etc.).
- Diversification of property types: Mitigate the impact of changes in specific demand segments by owning different types of properties, such as studio apartments for singles, condominiums for families, office buildings, and retail stores.
- Diversification of building age: Balance cash flow and asset value by combining relatively new properties with high asset value but low yields with older properties that are less expensive but have repair risks.
3. Importance of Periodic Review (Rebalancing)
A portfolio does not end once it is built. Changes in the market environment or in your life stage may cause the asset allocation you initially set to be out of balance. For example, if real estate prices rise significantly, the proportion of real estate in your portfolio may unintentionally become too high and the balance of risk may be lost.
This is where periodic rebalancing (readjustment of asset allocation) becomes important. The portfolio's condition is checked periodically, such as once a year, and the portfolio is returned to its original target allocation by selling some of the assets that have increased in value and buying more of those that have decreased in value. This steady maintenance is the key to achieving stable asset management over the long term.
Conclusion: Real Estate is the Cornerstone of Long-Term Asset Building
This article has explained the importance of real estate in an investment portfolio from various perspectives. Real estate offers many advantages over other financial assets, including stable income gains, resistance to inflation, and tax advantages. By taking advantage of these characteristics, it is possible to limit overall portfolio risk and lay the foundation for stable asset building over the long term.
Of course, real estate investing also entails risks such as vacancies and rising interest rates, but these can be well managed with the right knowledge and strategies. The key is to take a long-term perspective, build a portfolio that meets your goals, and manage it with persistence, rather than being swayed by short-term market trends.
INA&Associates, Inc. supports the realization of your prosperous future by proposing an optimal real estate portfolio tailored to each client's individual situation and goals. If you have any questions about real estate investment or concerns about your portfolio, please feel free to contact us.
Frequently Asked Questions (Q&A)
Q1. How much personal funds do I need to start investing in real estate?
A1. It is difficult to say, but if you can provide 10-20% of the property price as personal funds, you will have a wider range of financing options and can often start with more favorable terms. However, in recent years, there are programs that allow you to start with less personal funds, and depending on the property, a "full loan" (financing the entire property price) may be available. It is important to first consult with a specialist to develop a financial plan that fits your situation.
Q2. I live in a rural area. Is it possible to invest in properties in Tokyo?
A2. Yes, there is no problem at all. In fact, properties in Tokyo, where rental demand is stable, are very popular among investors living in rural areas. By outsourcing property management and tenant relations to a reliable management company, you can manage your rental properties with peace of mind, even from remote locations. Our company also introduces excellent properties in the Tokyo metropolitan area to clients throughout Japan.
Q3. What is the difference between real estate investment and J-REIT (real estate investment trust)?
A3. A J-REIT is a financial instrument that invests funds collected from investors in multiple properties and returns rental income and gains on sales to investors as distributions. The appeal of J-REITs is their high liquidity, which allows investors to start with a small amount of money and easily trade them on the stock exchange. On the other hand, physical real estate investment requires a larger amount of capital than J-REIT because you own the properties yourself. The major difference is that you can aim for a leveraged effect by using loans and have a high degree of freedom to decide your own property management policy.
Daisuke Inazawa
Representative Director of INA&Associates Inc. Based in Osaka, Tokyo, and Kanagawa, he is engaged in real estate sales, leasing, and management. He provides services based on his extensive experience in the real estate industry. Based on the philosophy that “human resources are a company's most important asset,” he places great importance on human resource development. He continues to take on the challenge of creating sustainable corporate value.
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