In economics, you need three things to do anything at all: Land, labour and capital.
Any economic endeavour requires these three basic resources, in varying amounts. From the simplest business you can think of (say, a kid setting up a lemonade stand on the side of the road) to the sprawling empires of multi-nationals, they all need some land, some labour, and some capital.
(Sometimes a fourth factor of production, entrepreneurship, is included, depending on which economist you talk to.)
Land doesn’t mean just real estate. It includes anything that comes from the land, like natural resources, forests, and water.
But for now, we’re focusing on the real estate element. By this I mean the square footage or acreage of land upon which towering office buildings, factories, apartments, and shopping malls are built. This is the commercial, residential and retail real estate that underlies nearly everything we as individuals and businesses do on a daily basis.
Your portfolio probably doesn’t have enough bricks and mortar
Given how essential real estate is to everything, you’d think that its importance would be reflected in the average investment portfolio. But it’s not.
In global stock markets, real estate is hugely underrepresented.
For example, take a look at the MSCI All Country World Index (ACWI). This is one of the largest aggregate global equity market benchmarks available. It captures large and mid-cap companies across 23 developed markets and 24 emerging markets. It includes nearly 2,500 stocks. The chart below demonstrates how the MSCI ACWI is broken down by sector.
The three largest sectors are financials, IT, and Consumer Discretionary (that is, non-essential consumer goods and services). And the very smallest slice of the pie is real estate, at just 3.14 percent.
It’s not just the MSCI ACWI where we see such a small weighting towards real estate. In the S&P 500, for example, it’s just 2.9 percent.
This is important: Because of the low weighting of real estate in broad equity indices, if you want listed real estate exposure, you will need to actively seek it out yourself.
But I own my home – don’t I have enough real estate?
When it comes to personal wealth allocation, a lot of investors factor in physical real estate that they own – whether it’s the roof over their heads, and/or an investment property. And they’ll think, I’m covered with real estate, so I won’t bother putting it in my stock portfolio.
This is understandable. But it’s wrong. You see, your physical real estate returns are tied to whatever city or area you’re living in.
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What this means is that limiting your real estate investments to the home you live in is like limiting the stocks that you buy only to companies located in your city. It’s the opposite of diversified.
In fact, this is the epitome of “home bias” – the tendency for investors to gravitate towards their domestic market, rather than diversify globally. (And in this case, it’s literally “home” bias!)
Real estate stocks and other listed real estate securities offer you a couple of additional advantages, from an investment perspective, over the roof over your head.
In the real estate world, especially real estate investment trusts (REITs), we can often buy a basket of real estate assets for far less than they’re worth.
For example, one REIT we’ve recommended in The Churchouse Letter trades at a 30 percent discount to book value. That means you pay 70 cents for one dollar of property assets.
This doesn’t mean necessarily that the discount will disappear any time soon (unless analysis suggests otherwise). But what it does mean is that you have a nice margin of safety. Simply put, would you rather pay 70 cents for a dollar of property? or a dollar?
Owning physical real estate as an investment has a lot going for it. But being a landlord can be a hassle. Chasing up tenants for rent, finding new ones when the lease expires and your tenant moves out, repairs, taxes, maintenance… it’s time-consuming.
But real estate holding companies and REITs in particular offer you much easier way to be a landlord. And the rent collection is automatic – dividends just slide straight into your brokerage account.
What’s more, you can buy properties that you’d never be able to if you were investing on your own. It’s unlikely you’ll ever own a price of a prime downtown Manhattan office building or a luxury retail mall in Beijing. But real estate stocks offer you an easy way to do just that.
So the next time you’re giving your portfolio a check-up, take a look and see what kind of real estate exposure you have. And if you’re looking for reliable, dividend-paying stocks backed by real assets, then have a think about property securities. (And we’ll be talking a lot more about this in coming weeks.)