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Debt Investing as Asset Class Diversification

Traditionally, real estate investing has been considered an alternative asset class. That changed, however, in 2016 when the Global Industry Classification System (GICS) was revised to give real estate its own asset classification.

While this change didn’t affect the fundamental nature of real estate investing, it did provide a new perspective on asset class allocation. Real estate could be considered a major asset class along with stocks, bonds, and cash equivalents. As a result, more investors started diversifying into real estate.

Another development that gave fuel to this new perspective on asset class diversification was the passage of the JOBS Act of 2012. Giving birth to new fundraising models like real estate crowdfunding (RECF) and marketplace lending, the JOBS Act opened up new opportunities in debt investing that, when coupled with real estate investing, gave many investors a new outlook on their portfolios.

What Is Debt Investing?

When traditional investors think about debt investing, what often comes to mind is bonds. Mortgages are another vehicle investors have used for debt investing. When the stock market is down, debt instruments are often a good hedge against losses and, in some cases, can even turn a portfolio around.

One reason investors turn to debt instruments is the risk factor. They’re not as risky as equities, but they also don’t produce the same returns. Since 1926, stocks have earned investors an average of 10 percent while government bonds have returned between 5 and 6 percent. Interestingly, real estate crowdfunding has been earning investors between 10 and 11 percent. This asset class is still relatively new and untested in all economic conditions, but one reason RECF and marketplace lending platforms are able to deliver these kinds of returns is because the technology that facilitates the transactions cuts down on costs allowing investors to save on fees and earn higher rates of return.

Diversifying Portfolios With Debt Investing

While higher returns are nice, the real benefit of marketplace lending platform investing is asset class diversification. The new method of investing opens up opportunities that investors might never find any other way. The platforms bring together real estate developers and project managers who are looking for capital to fund their projects and investors who want to diversify their portfolios beyond traditional stocks and equities.

The GICS system distinguishes between two types of real estate investments: REITs and real estate management and development projects. The latter consists of four subcategories:

  1.     Diversified real estate activities – Includes sale and development, management, and other services.
  2.     Real estate operating companies
  3.     Real estate development
  4.     Real estate services – Generally includes agents and brokers, appraisers, inspectors, and related services.

While real estate crowdfunding is not explicitly mentioned in the classification, RECF does often include opportunities that involve new real estate developments, fix-and-flip properties, and even long-term rentals. These deals can be in the commercial, industrial, or residential sector. Bottom line, the JOBS Act has provided a new way of diversifying portfolios for the average investor through real estate debt investments that didn’t exist a decade ago. These investments are powerful portfolio growth opportunities for investors ready to diversify their assets.

There are two ways to diversify an investment portfolio with these new real estate debt instruments.

  1. An investor may allocate a portion of their traditional investments into this new asset class, which means the total asset allocation of the portfolio doesn’t increase but the real estate asset class increases as other asset classes within the portfolio decrease. The benefit to doing this strategy is to reduce losses in underperforming asset classes while increasing the gains offered through real estate debt investing.
  2. Another way to diversify a portfolio is to add the real estate asset class to the investor’s portfolio without reducing any of the other asset allocations. In this case, the portfolio grows by the amount of the new investment, but if there are underperforming asset classes within the portfolio, then those won’t change.

Real estate debt investing through marketplace lending offers investors with all risk sensitivities, new opportunities to grow, and diversify portfolios by spreading risk and opportunities for returns across the entire portfolio.

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