Founding Father Thomas Jefferson was not only a good author and President, he was also a pretty good real estate investor.
In 1803, he was weary of the French owning the “Louisiana Territory,” a huge tract of land between the Mississippi River and the Rocky Mountains that stretched north to the Canadian border … and rightly so, knowing Napoleon's megalomaniac, empire-building tendencies. But he also knew Napoleon had a bit of a liquidity issue financing his war with Great Britain at the time. Jefferson bid $10 million for the port city of New Orleans and the adjacent 40,000 square miles of coastal land. However, Napoleon's number was $15 million. So Jefferson's counter-offer at $15 million was for the whole shebang of the Louisiana Territory, a total of 827,987 square miles. A desperate Napoleon did the deal, and Jefferson essentially doubled the size of the U.S. for about $0.03 per acre in what is now known as the Louisiana Purchase.
Needless to say that investment has had a pretty good return over the ensuing 214 years!
However, our mid-year survey of asset class performance shows real estate having a tough go of it over the last year compared to other investments:
As reminder, in any diversified portfolio there will always be some asset class that is underperforming. This reality is a feature and not a flaw in our investment approach — the diversified portfolio is greater than the sum of its parts and should fare well enough over the long-term as the underlying investments zig and zag.
Real estate investments play a special role in a diversified portfolio by providing protection against unanticipated increases in inflation. Think about it like this: the prices of high-quality buildings in great locations respond directly to inflation as the cost of replacing those properties increases along with the rising level of prices. Income from these buildings rises as leases mature and rents rise as well.
Investments in real estate should behave differently than equities and fixed income when unexpected inflation perks up. Because of the inflationary and current income benefits provided by real estate, expected returns for real estate are lower than the expected return of equities and could be seen more like paying an insurance premium to protect a portfolio against episodes when inflation rises more than expected.
Over the long-term, real estate provides a measure of stability to portfolios by dampening overall volatility associated with unexpected inflation. If inflation expectations were continually met, real estate would only play a minor role in a diversified portfolio. It is only because inflation seems to show up unexpectedly from time to time that makes real estate a necessary part of a diversified portfolio.
Or just forget all that and stick to Mark Twain's investment guidance: "Buy land. They are not making it anymore!"