Two Reasons to Rethink Real Estate Investing

In today's risk-conscious environment, investors want to hedge their bets on every asset class. Fortunately, unlike 2007, it is easier and cheaper for individuals to potentially mitigate downside risks in real estate by investing in real estate mutual funds that can go both long and short. So far, there are only a handful of these funds and—full disclosure—Altegris, my firm, offers one of them. Typically, these long-short real estate funds buy securities such as REITs and real estate operating companies, and hedge their positions with ETFs and derivatives, or by purchasing put options, writing covered call options or selling securities short. It is important to note that short selling is considered speculative and involves financial risk.

The second concern, rising interest rates, is clearly on investors' minds after years of historic low rates. Conventional wisdom holds that when interest rates go up, the value of real estate goes down, but that assumption does not always ring true for the entire real estate sector, according to an analysis of REIT values we published in 2014. After examining seven periods of rising federal funds rates going back to 1972, the white paper concluded that during those seven periods of higher rates, REIT values (including dividends) increased in five.

That's not so mysterious. Higher rates can also reflect a more robust economy. As economic activity increases, vacancies can fall, rents can increase and real estate prices can climb. If rates keep rising, of course, economic activity can stall and demand for real estate can wilt. But at that point, rates could likely fall once again to spur economic activity and real estate values would likely change again. The cycle repeats.

Another white paper we published adds weight to this finding. Taking data from January 1976 through December 2014, it found that adding publicly traded real estate to a stock and bond portfolio has historically improved a portfolio's risk-return profile versus one comprising solely stocks and bonds.

As with all alternative investments, real estate may not be suitable for everyone. What I'm suggesting is a new way to look at real estate investing—that the specter of rising interest rates should not be a deal-breaker, and that with hedges in place, there's potential to mitigate risks or even profit during a market downturn.