Recessions present financial advisors with one of the biggest professional challenges they can face. Imbalanced and rudderless portfolios are exposed. Securities plummet as panic selling ensues. Clients and investors often lose a lot of money.
We all know how tough it can be to predict such events—or at least, predict them timely enough to dodge the oncoming financial freight train. Given this inherent risk, strategies should be adopted to prepare for a recession by balancing client portfolios with assets that historically experience less volatility than securities.
The price of stocks and other securities often exhibit fat-tailed distributions. Extreme events tend to hide behind a sample mean that does not predict the actual population mean, so advisors sometimes forget that these events have a much higher probability of occurring than they do in a normal distribution. These “black swan” events often cause economic recessions: the 2001 dot-com bubble, the 2008 financial crisis and the current COVID-19 pandemic.
Savvy advisors look to explore other asset classes, like commercial real estate, to build a balanced portfolio strategy for high-net-worth clients that can mitigate the effects of extreme events. While these events are inherently difficult (or functionally impossible) to predict, a proper balance of carefully chosen investments can offer a buffer against the damage of a downturn and ultimately position clients for a quicker recovery when the markets rebound.
One of the primary reasons real estate investments can have greater resilience against a market panic is their inherent illiquidity. Stocks and other securities can be quickly converted to cash; buildings cannot. This feature removes much of the panic selling from real estate, which helps advisors and clients ride out the storm amid volatility in the securities market.
Indeed, even in a typical market, security investments tend to experience more variance over a shorter time series. Clients overleveraged in securities can enjoy higher returns, but they're also at greater risk for substantial losses, which almost always results in blame and deterioration of a relationship with their advisor. Without strategically selected real assets balancing risk in a portfolio, even moderate negative market shifts can result in considerable losses for clients.
Which real assets should advisors take into consideration? An obvious suggestion is real estate, and more specifically multifamily investing, which offers superior elasticity to other assets like retail outlets and office buildings.
First, it’s important that advisors effectively communicate why this sector is attractive to investors. Apartment managers work with shorter-term leases and have more ability to adjust rental rates based on market shifts. They can flex rates quickly to retain occupancy and income during a down market, and then regress back to the mean as markets rebound. Apartments also provide shelter to some 65 million Americans (and growing), giving them a considerable reliability advantage over other investment types. Finally, vertically integrated real estate developers can maximize real asset returns by improving management and property value of acquired properties, thus boosting net operating income.
In a world full of inherent volatility, real estate is an established asset class, and investment strategies that leverage the advantages of multifamily often have an improved chance of resilience and recovery. Overleveraging your clients in securities or risky business ventures can make them critically vulnerable to extreme events. If you educate and advise them about balancing a portfolio with quality real assets, this can help push them back toward the mean and weather a rough market.
Ari Rastegar is the founder and CEO of Rastegar Property Company, a technology-enabled private real estate investment firm.