January 11, 2022
The Benefits Of Investing In Real Assets
The practice of owning land, property, and other real assets has a long, rich history. Around 12,000 years ago, society began to favor permanent structures and more reliable forms of food sources like agriculture. Physical ownership of precious metals dates back 5,000 years to Ancient Egypt when gold began to be used for jewelry, decorations, or charms, and copper was cast for weapons, tools, or statues.
Modern methods of investing in real assets have had a much shorter lifespan. Congress enacted legislation in 1960 allowing REITs to be created, and in 2012, passed the JOBS act that paved the way for equity crowdfunding platforms, like FarmTogether, to become mainstream. Today, there’s an estimated $235 trillion of global investable real assets.
There’s far more complexity and opportunity surrounding real assets than you might expect, however. Let’s define the market, compare real assets to traditional financial assets, and dig into the portfolio benefits of this asset class.
Defining Real Assets
Real assets are an investment class of tangible assets that have inherent value derived from their physical characteristics. You can touch and utilize these investments and they typically provide some sort of benefit to society through their use. Examples of real assets include:
- Real Estate: Land, residential, and commercial properties, including REITs
- Infrastructure: Assets and networks used to transport, store and distribute, such as toll roads, pipelines, airports, and cellphone towers.
- Natural resources: Oil, precious metals, or commodities that provide society energy, raw materials, or food for consumption.
In comparison, financial assets are a liquid property that derives value from a contractual right or ownership claim. They can be physical or intangible. Common financial assets include stocks, bonds, or mutual funds; outside of the investment value of the assets, there’s little practicality or daily use of these investments. The world’s wealth is fairly evenly split between these two classes with 52% of the world’s wealth tied to financial assets and 48% invested in real assets.
Real Assets vs. Financial Assets
There are several similarities between real and financial assets. Both investments represent an economic resource that holds value. Both can potentially provide investors ongoing cash flow, as real assets may yield ongoing cash flow from operations or rent while dividend stocks or fixed-income bonds yield perpetual distributions. Further, within each type of asset class, there’s a range of investment opportunities with different characteristics. For example, both gold bars and commercial real estate are real assets, yet have varying levels of risk, liquidity, cash flow, and expected returns.
On the other hand, there are quite a few differences, too. Financial assets generally do not have any value beyond what it's worth as an investment. They only represent a contractual agreement to claim money from banks, debt from debtors, or share capital from companies. Meanwhile, real assets have intrinsic value that is derived from their physical qualities. In addition to contractual agreements to claim operating or rental income, real assets hold value because they are physically useful. This allows real assets to preserve long-term value - especially during inflationary periods - better than other assets. Real assets may also require additional carrying costs, like maintenance, security, or insurance.
Because financial marketplaces make it easier to buy and sell stocks or bonds, financial assets are generally more liquid and easier to convert to cash. Financial assets sold on public exchanges are generally more transparent to meet regulatory information reporting requirements. However, the efficient market hypothesis would indicate that this means greater potential returns for private markets, like real estate or farmland.
The Benefits of Real Assets
Investors have historically turned to real assets as an effective way to diversify their portfolios. In the past, real assets have had low correlation to stocks and bonds, and real assets generally have low correlation to other types of real assets as well. The real estate market, for example, has traditionally moved in long-term cycles that moves independently of broader financial markets. Natural resources have had a negative correlation with the U.S. dollar and have protected against weakening dollar values. Meanwhile, investing in farmland over the past three decades reduced a portfolio’s overall risk and yielded returns up to 1.8% higher than a traditional portfolio holding only financial assets.
Real assets have performed exceptionally well in protecting against inflation. In fact, real assets have outperformed global equities and bonds during the past several periods of high, rising inflation. Given that commodities make up a large portion of the CPI - the index most often tracked to measure inflation - this asset class is most positively correlated with inflation. Similarly, farmland, which produces these commodities, has traditionally held a 70% correlation to the CPI.
While many investors cite precious metals’ scarcity value as an inflation hedge, REITS and other physical properties have outperformed gold during the last three periods of higher inflation. Properties that are rented or operated may also generate income that can be hedged against rising prices. Through rent rate adjustments on short-term leases or higher yield pricing for crops, the cash flow from certain real assets can respond to changes in inflation.
For most real assets, there is also long-term passive income potential. The location, class, and use of real assets determine both the yield and in some cases, operating income. Farmland’s average return on investment over the past 30 years is around 11%, and total crop cash receipts from operating income in 2021 are expected to be roughly 18% higher than last year. Meanwhile, the average return for commercial real estate is 9.5% and residential real estate is 10.6%. REITs invested in underlying properties or land may also issue high-yield dividends, with the current average annual dividend being 3%. Meanwhile, FarmTogether delivers quarterly or annual cash dividend distributions and rental payments depending on your investment’s crop schedule.
In addition to operating income, certain real assets have traditionally experienced appreciated values over time. The inflation-adjusted valuation of farmland in the United States has more than doubled since 2000, and cropland values in the United States increased 7.8% between this summer and last. Commercial real estate prices have increased all but one quarter (Q3 2020) over the past five years and have performed well during the last several periods of rising interest rates. Meanwhile, precious metals also have a history of price appreciation; although gold prices slightly declined in 2021, their price has still increased 39.7% over the past three years.
Why Real Assets… Especially Now
There are several unique conditions that make real assets a very intriguing option for investors today. First, real assets may potentially be undervalued. With the stock market wrapping up the year at its all-time high, the price of real assets relative to financial assets is at its lowest point since 1925. Second, equities have demonstrated that they offer poor protection against inflation in the past. With government entities forecasting inflation to average 7% through the first quarter of 2022, real assets that have historically provided a better hedge are worth the consideration.
Last, with continual uncertainty of how future coronavirus strains will impact the global economy, some expect increased market volatility with a potential market correction in 2022. The Federal Reserve recently confirmed their efforts to reign in monetary policy to combat rising monetary supply and rising prices. Real assets, such as farmland, have performed exceptionally well during prior economic downturns, with some real assets considered “less economically sensitive” to GDP growth or macroeconomic conditions.
Diversifying Your Portfolio With (and Across) Real Assets
Though they’re traditionally less liquid than financial assets, real assets historically have had low correlations with other assets, can offer a hedge against inflation, can generate operating cash flow, and tend to appreciate in value. Through modern investment vehicles and digital platforms available today, it’s becoming easier to invest in real assets and reap the variety of portfolio benefits farmland has to offer.
Disclaimer: FarmTogether is not a registered broker-dealer, investment adviser or investment manager. FarmTogether does not provide tax, legal or investment advice. This material has been prepared for informational and educational purposes only. You should consult your own tax, legal and investment advisors before engaging in any transaction.
Was this article helpful?