Why young investors shouldn’t forget the “one-third property” rule
You should invest one-third of your money in stocks, one-third in cash, and one-third in property. This classic, and oft-repeated wisdom was almost second nature to earlier generations, not least stock market greats like André Kostolany. Nowadays, however, the “one-third property” rule in particular seems to have been increasingly forgotten by younger investors. Why is that?
New investors take the market by storm
The robust stock market boom in the wake of 2020’s Corona Crash and the community-building of groups such as wallstreetbets have had an extremely satisfying side effect. It is almost impossible to remember a time when so many young people were so passionate and focused on the available options for investing their own money. Technology stocks and “growth stocks” have proved particularly popular – and the same can be said for cryptocurrencies, which seem to be increasingly gaining acceptance as an alternative to gold or traditional currencies.
On the back of such investment strategies, lots of investors posted solid returns over the course of 2021. But many portfolios run the risk of are not being sufficiently diversified across different asset classes. In particular, achieving the right proportion of real estate often seems like a problem. While a number of private investors already own their own homes and therefore have a substantial real estate allocation among their total assets, a large number have so far devoted little attention to the qualities of real estate as an investment product. However, several inherent features have always made real estate an attractive portfolio hedging instrument: low correlation with the overall performance of stock markets, low volatility and (similar to stocks) a high level of protection against inflation.
Different investments have different specific features
However, the above advantages do not apply equally to all forms of indirect real estate investment. Consequently, it is important to understand the potential advantages and disadvantages of individual investment vehicles. In many cases, investors include real estate stocks (or real estate ETFs) in their portfolios. However, these not only correlate fairly closely with developments on the real estate market, they also mirror the frequent ups and downs of the stock market to some extent. As a result, shares in listed real estate companies may at times trade at a discount to their book value, i.e. the fair value of the portfolio of property they own. In the case of real estate crowdfunding, which is also popular, annual returns are secure in that they take the form of a fixed interest rate – but investments are usually structured as subordinated loans or bonds. In such cases, investors do not benefit from any increases in the value of the properties they indirectly own, nor do the investment products themselves offer reliable protection against inflation. In addition, investors run the risk of losing their entire investment if the property developer has to file for bankruptcy or the project runs into difficulties.
Funds – analogue or digital?
A traditional real estate mutual fund, in comparison, offers the opportunity to benefit from rising asset values, combined with a lower correlation with developments on the stock market – plus annual distributions. Nevertheless, it is largely Gen Xers and Baby Boomers who invest in property funds. Among younger investors in particular, funds frequently have a somewhat fusty image, triggering associations with bank counters and stuffy investment advisors in suits and ties.
Nowadays, however, it is also technically possible to tokenize fund investments (and loans). Real estate assets can be deposited in digital form as security tokens, which are subsequently stored in an investor’s wallet and – at least in theory – can be transferred as freely and in as decentralised manner as cryptocurrencies. Unlike Bitcoin, though, the token always has an intrinsic value, which is why it is likely to be much less volatile. Currently, a legal framework is being developed in Germany to make this form of “virtual” real estate investment freely tradable. If successful, this will allow the real estate fund industry to reinvent itself and become more attractive to a new generation of investors.
ESG moves to the top of the agenda
Another aspect that is gaining in importantance, especially among younger investors, is ESG (Environment, Social, Governance). Accordingly, investments should not have a negative environmental or social impact. Then there is “impact investing”, which goes even further and focuses on the positive impact and added value of an investment. In the real estate sector, too, a growing number of fund managers are choosing to develop sustainable products and include them in their portfolios. And this is about more than merely ensuring that new properties are built to the highest KfW energy-efficiency standards and are more environmentally-friendly in day-to-day operation. There is also the question of how densification projects in already built-up areas can be delivered as efficiently as possible. Social aspects are equally important. After all, the issue of affordable housing is one of the most pressing issues of our time and is of major relevance to society as a whole. And that is precisely why some fund managers have already started to include subsidised housing units in their portfolios, with very tangible economic benefits: rent-capped and subsidised rental housing is almost always guaranteed to be fully leased – which in turn guarantees stable cash flows for investors.
