How to Invest in Real Assets for Your Portfolio

Investing in real assets offers advantages within a diversified financial portfolio. These physical properties have inherent value, distinguishing them from traditional financial instruments like stocks and bonds. Including real assets can provide a hedge against inflation and contribute to portfolio diversification, offering stability during varying economic conditions.

Understanding Real Assets

Real assets are physical, tangible items that hold intrinsic value. Unlike financial assets, which gain value from contractual claims, real assets exist in the physical world. This category encompasses a range of investments.

Real estate includes residential properties, commercial buildings like offices and malls, and raw land. Commodities are raw materials like gold, silver, oil, and agricultural products. Infrastructure assets include transportation networks, utilities, and telecommunications. Natural resources, such as timberland and farmland, can generate income and appreciate in value. The tangible nature of these assets allows them to preserve purchasing power during inflationary periods, as their values often rise with consumer prices.

Direct Investment Methods

Directly investing in real assets involves acquiring and owning the physical property, which requires significant capital and active management. For real estate, this can mean purchasing residential rental properties or commercial buildings. The process involves identifying suitable properties, securing financing, and managing the asset, including tenant screening, maintenance, and rent collection, potentially incurring property management fees ranging from 8% to 12% of gross rents.

Direct real estate ownership has tax implications. Property owners can deduct mortgage interest, property taxes, and operating expenses. Depreciation deductions allow investors to write off a portion of the property’s cost over its useful life, which can reduce taxable income. When selling a directly owned property, any profit is subject to capital gains tax; long-term and short-term capital gains rates apply. Investors can defer capital gains taxes on investment properties by utilizing a 1031 exchange, reinvesting the proceeds into a “like-kind” property.

Direct ownership of physical commodities involves purchasing metals from reputable dealers. A concern with physical commodities is secure storage, often incurring associated fees. Investing directly in agricultural land or timberland involves purchasing the acreage, which can be a substantial upfront cost. Investors in farmland might lease it to farmers, receiving regular rental income or a share of crop production, or engage in custom farming where an operator manages the land. This hands-on approach offers direct control and potential for appreciation but also carries responsibilities for management and upkeep.

Indirect Investment Methods

Indirect investment methods allow individuals to gain exposure to real assets without the direct responsibility of ownership and management. Real Estate Investment Trusts (REITs) are companies that own, operate, or finance income-producing real estate. REITs are traded on major stock exchanges, making them a liquid investment option. To qualify as a REIT, a company must distribute at least 90% of its taxable income to shareholders annually, which often results in high dividend yields.

Types of REITs include equity REITs that own and manage properties, mortgage REITs (mREITs) that provide financing for real estate, and hybrid REITs that combine both strategies. Dividends from REITs are taxed as ordinary income at the investor’s marginal tax rate. However, a portion of REIT distributions may be considered a return of capital or capital gains.

Commodity Exchange-Traded Funds (ETFs) and mutual funds provide exposure to a basket of commodities or specific ones, often by investing in futures contracts or, less commonly, holding physical commodities. The tax treatment of commodity ETFs varies based on their structure, with different rules applying to futures-based funds and those holding physical precious metals.

Infrastructure funds invest in projects like toll roads, utilities, and communication towers. Natural resource funds focus on companies involved in the extraction, processing, or management of resources. These funds, typically offered as mutual funds or ETFs, provide diversification within the real asset category. Private equity funds also invest in real assets, but these have higher entry barriers and are less liquid, often targeting institutional or accredited investors.

Important Considerations for Investing

Diversification is key when considering real asset investments. Spreading investment capital across various asset classes and different types of real assets can help mitigate risk and enhance overall portfolio stability. Relying solely on one asset type, even within real assets, can expose an investor to concentrated risk.

Liquidity is another factor, as many real assets, particularly direct property ownership, are inherently illiquid. Selling a physical property can take several months or even longer, which impacts an investor’s ability to access capital quickly. In contrast, publicly traded indirect investment methods like REITs and many ETFs offer greater liquidity, allowing for faster transactions.

Thorough due diligence is essential before making any real asset investment. For direct investments, this includes property inspections, title searches, environmental assessments, and financial analysis. For indirect investments like funds, reviewing the prospectus, understanding expense ratios, and researching the management team is advised.

Seeking professional advice from financial advisors, tax professionals, or real estate experts can provide tailored guidance. These professionals can help navigate complex investment structures, understand tax implications, and align real asset investments with individual financial goals.

Real asset values can be influenced by broader market cycles and economic conditions. Factors such as interest rates, inflation rates, and overall economic growth can impact the performance of real assets. Understanding these cyclical influences can help investors make informed decisions about when and how to allocate capital to real assets.