Real Estate: Diversification And Hedge Against Inflation?

by: Intelligent Speculator

In my quest to become financially independent, I'm building income streams that will hopefully get me there early with a few stable and growing sources of money. I do write about my progress every month and while I currently generate my income mostly from my online company and my retirement investment accounts (dividend and ETF), I've also discussed the desire to buy some real estate in the medium term (a year or so). I will be providing an update frequently but today I wanted to give a better breakdown into why I think real estate is a great addition to my portfolio.


One clear benefit is that there is very little correlation between real estate and the stock market so the chances that both sources of income would be knocked down at the same time are much smaller than if I was 100% in stocks.

Hedge Against Inflation

You might think that the recent housing crisis proves that it's difficult to rely on real estate but I think most of us would agree that there was a bubble in housing. I read a very interesting piece by Cognitive explaining that real estate prices increase by the sum of inflation and real wealth increase, as you can see in the following chart:

If you're not quite convinced yet, look at this much longer term chart which spans over a century:

That is valuable because I don't necessarily want to hold on to the major inflation hedges right now. Gold has no yield and inflation bonds bring extremely small returns (like most bonds these days) until inflation shows up.

Major Downside

The main downside of course to real estate is that it's illiquid. It's difficult to sell quickly, especially in weak markets and there are tremendous transaction costs (closing, agents, etc) which makes flipping houses or commercial buildings very difficult to pull off. It's not something that I'll be looking to do personally. I'm much more interested in buying a few great values in some emerging neighborhoods in order to generate consistent and rising income over the very long term.