In a recent article in the Wall Street Journal, “Real Estate Stocks Are on Sale, but No One Is Buying,” WSJ reporter Ken Brown discusses the underlying love-hate relationship investors have with real estate and the fact that real estate stocks are a lonely asset right now, waiting and hoping to be scooped up, in spite of the fact that they’re more affordable than ever.  What gives?

It’s tough to be a real estate stock these days…

According to Brown, “Real estate investment trusts (REITs) have lagged behind the S&P 500 by more than 15 percentage points over the past 12 months. REITs on average are trading at a 16.4% discount to the assets they own, one of the widest gaps that has ever occurred outside of a recession, according to Green Street Advisors.”

REITs are trading at a discount because nobody is buying them.  So, what are they buying?

Wait for it…

“… investors love private real estate funds, which don’t trade on the market and so never are valued at a discount to their assets.”

Yesss!  Investors are discovering the benefits of investing in private real estate funds, and I couldn’t agree more.  While a 16.4% discount on your purchase sounds like a steal (and who doesn’t love getting a great deal?), successful investors know that stability generally outperforms risk and volatility — sometimes by a huge margin (more about that below).  This is a crucial point I’ve been making in my live presentations about Guardian, our private real estate fund.

Now, the WSJ article is referring to big investors with billions of dollars in assets, so their investing criteria is not exactly the same as ours.  Investors of that level have to be able to deploy massive amounts of capital, which limits their choices.  Fortunately, Guardian invests on a smaller scale, so we have much more flexibility in the assets we choose.

Brown gets into the nitty-gritty in these next bits:

“The love-hate situation is driven by two main factors. Investors have sold REITs because of rising interest rates, which have left their yields less attractive. Meanwhile, investors also have been pouring cash into private equity, hedge funds and other alternative investments on the belief they will outperform public markets.

Yet REITs historically have outperformed similar private funds, according to Green Street. And when REITs are trading at big discounts, as they are today, they outperform by a lot.  The question is why investors would choose to invest in private funds when publicly traded REITs are on sale. The likely explanation is that investors believe private funds are less risky because their values don’t bounce around like stock prices do. Risk, though, isn’t volatility but rather the chance of a permanent loss of capital.”

Bingo!  Investors believe private funds to be less risky because they are less volatile.  If this statement sounds confusing or redundant in and of itself (“risky” because they’re “volatile”), you’re not alone.  A common misconception is that risk and volatility are synonymous; they are not.  However, they are related.  (If you’ve heard any of my talks, you’ll know that I always try to drive this point home!)  In general, the more volatile the investment (the greater the ups and downs), the higher the risk.  Think of it this way: the risk is in whether your investment is up or down in value (the inherent volatility) when the time comes that you must sell.  Not only is it important to time the market, but don’t forget about what’s going on below the surface with all the volatility.  Even if you were to time the market just right and sell your investment at a high point, every time your investment went down in value over the years, you lost money and were robbed you of a better return in dollars.  Sure, it eventually will go up again, but the remaining dollars will always have to work that much harder just to get back to even.

Here’s one of my favorite examples: If you invested $100,000 in the S&P 500 43 years ago, it would be worth $3.8M today.  While the stock market has seen a lot of volatility over the last 43 years, it has produced a 10.09% average return.  However, that same $100,000 invested 43 years ago, in an asset that produced a consistent 10% return with no volatility, would be worth $6.0M today.  That’s $2.2M more dollars earned with the “same” 10% return!  Ahhh, but they are not the same.  The difference is in the presence or lack of volatility.

Even though both investments earned an average return of 10%, over 43 years of earnings, the consistent 10% return produced $2.2M more than the volatile 10% average return.

I got so much satisfaction from reading this article, as it was yet another confirmation of what I believe and have experienced to be a sound investing principle: Stability and consistency help protect your principal and generate higher returns.