Risk versus return (reward) – they tend to work in opposite directions. When one side goes up, the other side must come down. Right? Well, not necessarily…What is your risk tolerance?   Green Bison Capital spends an equal amount of time and energy on assessing returns and evaluating risks. Even better is when we can evaluate returns that are adjusted for risk.

William Sharpe, an economist and the 1990 winner of the Nobel Prize in Economics, developed a concept of evaluating risk-adjusted returns. His concepts are important analytical tools to corporate finance and investing including portfolio evaluation.  He is known for creating the Sharpe Ratio, a value used to measure the risk-to-reward ratio of an investment.

In the equation above, the risk free return is generally considered to be the annualized return one would expect to earn if invested in U.S. Treasury bonds….let’s consider this to be about 3% for this example.  The higher the Sharpe Ratio, the better the investment’s historical risk-adjusted performance.  Please ask your financial advisor or certified financial planner about Sharpe ratios on the investments in your portfolio.

Real estate has an attractive risk-adjusted return profile…and correspondingly a good Sharpe Ratio. Check out the graph below for a comparison of the risk versus return for various asset classes for a 20-year period from 1993-2013. Green Bison likes this large timeframe because it includes two recessions (i.e., the dot com bust in 2001 and the credit crisis in 2008) and their subsequent market recoveries.  When volatility is considered (i.e., risk as shown in the horizontal axis in the graph below), the risk-adjusted return for real estate has historically been greater than equities, bonds or commodities.

The Real Estate value shown in the graph above (NCREIF Property Index) comprises a very large pool of individual commercial real estate properties acquired in the private market for investment purposes only.

The values of return and risk plotted in the graph above are shown in the following table along with their corresponding Sharpe Ratios.

Please remember that these returns are before taxes. It is important to consider the estimated returns you will earn after taxes.  See the July 2019 blog for more on that. Direct investments in real estate will make the after-tax returns shine even more than paper asset investments (e.g., equities, bonds).

Green Bison also likes direct real estate investments because they provide added diversification to portfolios. Direct investing in private real estate offerings is a notably different asset class compared to traditional equities and fixed income investments.  This is a good investment strategy to diversify because this type of real estate investing tends to not correlate to those asset classes that are in the public markets.