>> All right. Let's take a look here. All right. Here is my subject matter today. Is this on? Okay. Real estate, it's really on now. Can it be added to a Boglehead portfolio? Should it be added? How should it be added? Let's talk about it. Something we don't talk about a lot.

First, some disclosure. I am not a financial advisor. I'm not an accountant. I'm not an attorney. I'm not licensed to do anything in the great state of Maryland. So this is all for your entertainment and information only. I have conflicts of interest. I own a for-profit company called the White Coat Investor.

Some of our advertisers are real estate investing companies. I'm not going to mention any of those today, but be aware I have that conflict of interest. The only company I'm probably going to mention today is Vanguard, which I have yet to get to advertise with me. So I don't have a conflict there.

Okay. Here's what we're going to talk about. We're going to talk about the case for real estate in general. Then we're going to talk specifically about the case for private real estate, following which I'm going to present the most important slide in this presentation. I call the real estate continuum.

All right. First, the case for real estate. The first reason why someone might want to invest in real estate is because the returns are high. When you're building a portfolio, you want multiple high-returning asset classes. Maybe you want some lower-returning ones as well. So what are we talking about?

We're talking about stocks. We're talking about real estate. We're talking about small business. Maybe some speculative asset classes out there might have higher returns. But real estate returns in general are similar to stock returns, but are a little bit more easily leveraged. Once you leverage them, the returns tend to be higher.

Second reason, low correlations. When building a portfolio, again, you want lower correlations between your asset class. If they're higher than about 0.8, you're not doing a lot of good adding that asset class at all. Correlations, of course, go from minus one up to one. The lower, the better when it comes to building a portfolio.

For example, between US and international stocks, it's anywhere from 0.5 to 0.94. With bonds, it's almost zero. With commodities, it is zero. Bonds to commodities actually have negative correlation. In comparison, comparing US stocks to US publicly traded real estate investment trust, the correlation is about 0.45. If you compare that to private real estate, it's as low as 0.17.

That's a good reason to invest in the asset class. The third reason, real estate tends to be very inflation resistant. These are real assets. They tend to go up in value with inflation. The value of income, of course, income property is highly dependent on the rents that you are charging and collecting.

So as inflation rises and you can raise the rents, then that provides some inflation protection, at least in the long run. It's also easier to pay back fixed rate debt with inflated dollars. If you have a bunch of low interest rate fixed rate debt, like a lot of people do right now, and inflation goes up, that can be a really great place to be sitting in.

Real estate also has relatively high cash flow. A higher percentage of your return tends to come from income than from capital gains. That's not always a good thing, especially if you don't need the income. But it can be useful for decumulation years, and also for replacing earned income during the working years.

Another great thing about real estate is that it's a little bit easier to add value. You're extremely unlikely to add value to your portfolio by studying and picking stocks. If you have not learned that yet, you will learn it this weekend. But all real estate is local. An active management has the potential to work better with real estate than it does with stocks.

You can also boost returns, aka earn money by doing the work yourself when something needs to be done. That introduces some aspects of a second job, which a lot of people find not very attractive about real estate investing. But it is an opportunity to add some value. Another awesome thing about real estate are some tax advantages, which frankly are unfair.

They're unfair tax advantages. For example, if you sell your home, and it's appreciated less than $250,000 since you've been in it, all that capital gain, you don't have to pay capital gains taxes on. If you're married, it doubles. Depreciation. Basically, the government says your house is going to be worthless in 27.5 years.

The truth is your house isn't going to be worthless in 27.5 years. It's overly generous. Even for businesses, it's like 39 years. Still overly generous. That warehouse is not going to wear out completely in 39 years. Then when that depreciation is recaptured at a sale, it's only recaptured at 25 percent.

For those of us in the highest tax brackets, that's a great deal. Take the break at 37 percent, pay it back at 25 percent. If you get real estate professional status, which admittedly is not all that easy to get, or you take advantage if you're doing short-term rentals, the short-term rental loophole, you can use passive losses to offset your earned income.

I know doctors, high-powered surgeons, whose spouse qualifies as a real estate professional, who pay no taxes on their clinical income because of depreciation from rental properties. Mutual funds, unfortunately, can't pass through their capital losses, but a partnership investing in a real estate property can do so. Those depreciation losses, they're really only losses on paper, but they can pass them through to you.

Opportunity zone funds are another excellent way that real estate offers some tax advantages. Basically, allows you to pay less on capital gains that you get from that real estate. But the very most tax-efficient way to invest in real estate, is to invest directly in properties that you buy, depreciate, and exchange rather than sell into another property, a bigger property usually, and then depreciate some more, exchange it into a bigger property, and finally you die without ever selling anything.

Well, if you never sell anything, you never pay capital gains taxes. Your heirs get to step up and basis a debt. It's incredibly tax-efficient. All that depreciation sheltered income, and then nobody ever pays the capital gains taxes. So that's one of the cases for real estate, these unfair tax advantages.

Okay. So we're talking about the case for overweighting real estate, because most of you own real estate investment property whether you like it or not. The total stock market index at Vanguard owns three to four percent real estate. Three to four percent of it is composed of these publicly traded real estate investment trusts.

However, 90 percent of real estate by dollar value is not publicly traded. It's not on the stock markets. It turns out investors only purchase about 22 percent of single family homes, and only three percent of those are purchased by large institutions. They're not on the markets. It's a completely separate economy from what we're investing in, in Vanguard index funds.

If you compare that to non-real estate businesses, you'll see that there's a few thousand publicly traded businesses in the country, but there's 27 million total businesses. However, the truth is almost all of those are one-person businesses. Twenty-one million of those only have one employee. Eighty percent of profits, when you look at non-real estate businesses, 80 percent of profits in the country are coming from those publicly traded businesses from stocks.

That's not the case in real estate. So the idea is that if you overweight real estate in your portfolio, more than a total stock market index does, that's a little more representative of the real economy and real wealth in the country. Okay. So enough about real estate in general.

Let's talk now about private real estate. Okay. What is the case for private real estate as compared to just investing in real estate investment trusts that are publicly traded on the stock market? Well, you still get high returns. They might not be higher returns, as we'll discuss momentarily. You get lower correlation and perhaps better risk-adjusted returns.

You may collect an illiquidity premium. You certainly should by theory, whether you do or not is a different question. You may get lower expenses. A lot of these, there's a lot of regulation when you are publicly traded on the stock market. It costs a lot to comply with all those regulations.

However, when you're involved in these smaller properties, syndications, etc., you can have those regulated according to regulation D, which is a much lower barrier. It has its upsides and downsides. There's fewer regulators looking at it, but it costs less to comply with it. So you may have lower expenses in that regard.

You're also often investing in smaller properties. A duplex just isn't going to fit into a publicly traded REIT. It's too big. It needs to invest too much money. It's not going to buy the duplex down the street from you. That might not be the case with private real estate.

It tends to be a less analyzed market, fewer people picking through it, fewer analysts looking at it. Of course, in these sorts of partnerships or whether you own it directly, the depreciation is passed through right to your tax return. Okay, but here is where the rubber meets the road.

2022 is not a great year for most of us. These are my actual portfolio returns from 2022. If you look at my overall return is about minus 10 percent. US stocks were down about 16 percent. Small value did a little better. International did about the same. Small international did even worse.

Bonds did not have an awesome year in 2022 either. I bonds were like one of those rare bright spots. Well, if I look at my private real estate compared to my public real estate that year, my public real estate got hammered right along with the stock market, did even worse, minus 23 percent.

But my equity real estate did about nine percent. On the debt side, I did a little bit better than that, nine and a half percent. To me, that goes, "Hey, there's something here. Maybe we ought to be looking at this a little bit more closely." Those are various hand-selected investments and how they did in that year.

Some of them did quite well. But on average, about nine percent that year. So, are private returns actually higher? This is a good question. The answer is it depends. I think the best answer is probably not on average. But the risk-adjusted returns probably are a little bit better, because they have lower correlation with stocks and bonds.

Once you incorporate it into a portfolio, it may do better. But the returns don't actually have to be higher for it still to make sense to invest there. So, here is a comparison in four sectors of the real estate investing space. Retail, and US office, and industrial, and apartments.

We're comparing private and public. So, the red line is the REITs, the publicly traded real estate. The blue line is the private. As you can see, it varies a little bit by sector, but more or less, it's about the same. However, when they look at these things more specifically in studies, you'll see a lot of studies that come back with data like this.

You'll see here, the second thing down there are these publicly traded REITs, and they did pretty darn well over this time period, which is about 20-year time period. It's up there 10.5, 11 percentage. If you go down about halfway, you'll see unlisted real estate. This is the private real estate.

It did not do nearly as well. It's about, what, eight percent. So, it was higher in that study for the publicly traded real estate. Numerous other studies have basically shown the same thing. Time periods are all a little bit different, but it's basically the same thing. You'll see that the public real estate did better than the private.

But then you start looking at studies where they look at incorporating into a portfolio to take advantage of the fact that the correlation is lower. This study from Yutahi et al concluded that the optimal portfolios had higher weightings of direct real estate investments as opposed to REITs, and that the optimal portfolios containing REITs are outperformed by those containing direct real estate investments.

So, it's not all about returns. If you look at the Sharpe ratio, private real estate, according to Black Creek anyway, has delivered better risk-adjusted returns for investors over the last 20 years once you adjust it for risk. By risk, they mean primarily volatility. The reason why is the correlation is just much lower.

You see over the last 20 years compared to the 10 years before that, the correlation of the stock market with publicly traded REITs has gone way up. It's gone up a little bit for the overall real estate market, but not nearly as much. So, it's just much lower correlation.

This is interesting data too when you look at this. You'll see there's a little bit of a lag. Because the stock market is marked to market daily, it goes down first. Likewise, publicly traded REITs go down first, and then the private stuff follows it. So, there's a little bit of a lag there.

If only private real estate didn't have such high transaction costs and such illiquidity, you might even be able to take advantage of that. This is interesting too. Once the stock market gets pounded, once publicly traded REITs go down more than 20 percent compared to their net asset value, then they do much better than private real estate over the next one to three years.

That's what this graph is showing. So, something to keep in mind there. All right. Enough about private real estate. Let's talk about the most important slide in this presentation, the real estate continuum. This is what it looks like. On the left side, you will see people who are basically real estate developers.

They go to the city, they get a permit, they break the ground, they dig the hole, they build the building. It's ground up construction. Then you move along to the next category. This is fix and flip. You buy a place, it's like the shows on TV. You fix it up, you renovate it, and then you sell it.

Coming next on the spectrum is short-term rentals. You're running a hotel business here. This is Airbnb, this is Vrbo. People are renting your house for three days or seven days, something like that. Next to that comes long-term rentals. You still own the whole thing, but you're now renting by the month or by the year.

After that is a turnkey property. Basically, you still own the whole property, but you're not doing any of the work. You've hired it all out. Somebody else finds it, they put the tenant in it, they manage it, they repair it, they sell it, they're doing everything. All you do is own it.

After that, we're getting into the more passive types of real estate investing. The next couple are available only to accredited investors, meaning an income of at least 200,000 for each of the last two years, 300,000 as a couple, or a million dollars in investable assets. We're talking about syndicated properties.

So the idea here is, 99 investors go in together and they buy a 200-door apartment complex, because none of them can afford it on their own, number one. Number two, you get some sharing of expenses a little bit, and you get professional management. None of those 99 investors are being called when the toilets clog.

It's a passive investment to them. It's mailbox money that comes in every quarter. But you own the property directly and it's a partnership, and so the depreciation is still passed to you. A private fund, often now structured as a REIT, even though it's still private, is just 15 or 20 of these.

You put 15 or 20 of these apartment buildings into one fund, and that's what a private fund is. Then of course, at the far end are the publicly traded REITs that show up in your total stock market index. As you move from left to right along the spectrum, you will see that you will require less experience, you will have less hassle, you will get more diversification, and as a general rule, you'll get more liquidity.

However, you're giving up control, you're giving up tax benefits, you are paying more layers of fees, and you probably, if all of this is done well, have lower returns because of that. So there's not actually a right or wrong way to invest in real estate, but there is a right way and a wrong way for you to invest in real estate.

You've got to match yourself up on that continuum with what makes sense to you. If your goal is you hate your job and you want out as soon as you can, and you'll do anything to do it, the answer might be building an empire of short-term rentals. On the other hand, if you're like, "I'm a retiree and I want to play golf for 12 hours a day, and I don't want to do any of this real estate stuff." The right answer for you might be, "I'll just take the real estate that's in the total stock market index, or maybe I'll just add a little bit of the Vanguard REIT index fund." That sort of a thing.

Everyone else has got to match themselves along that spectrum somewhere. Real estate, of course, is not mandatory. You already own it, whether you want to or not. Okay. So what we've talked about. Real estate, while optional, is a great asset class and often the first alternative that gets added to a portfolio.

Private real estate may not have higher returns than public real estate, but it does have some other advantages. There are lots of different ways to invest in real estate. You don't need and you certainly don't want to do all of them, I promise you. Make an honest assessment of what you want from your real estate investment before making it.

But you can invest in real estate without getting toilet calls. It is not always a second job. If you look at that spectrum, all of our real estate investments, my wife and mine, are on the far right side of that spectrum. Some of them are private and some of them are public, but nobody calls us for toilets, I assure you.

That is not the only way to invest in real estate. Real estate investing should not be a get-rich-quick scheme, but it can be a get-rich-quicker scheme. It's still going to take years, but using some hard work, some leverage, you actually can reach financial independence earlier, most likely doing that.

Of course, passive income is a great term. It is often not nearly as passive as it looks. All right. Thank you for your attention. Let me.