A Good Fit: Real Estate in Your Investment Portfolio
By Christopher P. Gullotti, MSFP
"I'm going to use my investment property to pay for my kids' college tuition."
"At least I know my real estate will continue to grow in value. I'm not sure
about my other investments."
"Investment property gives me a chance for much higher returns than other
investments."
Financial planners hear comments about real estate investments frequently.
Does investing in real estate truly offer financial opportunities? Many times
yes, but not always for the reasons people think.
* Next 37 17 investors only!
The first step is to think big picture. Consider your reason for investing in
the first place before deciding on which property to place an offer, or even
more broadly, whether you'll invest in foreclosed property, fair market-priced
multi-families, or undeveloped land.
Most likely, when you are 95 years old, you will not look across your hospital
bed to your children and say, "I'm so content knowing we had an average annual
return of 9% on our investment property." You will hopefully reflect upon
your joyous retirement years, your children's successes, or some other memory
that does not begin with a dollar sign.
Thus, the most important question you must ask yourself in determining your
investment needs is: What dream do I want my money to fund and how much money
will my dream take? The answers to the first part of the question might
include:
- providing income for my retirement.
- paying for my two children to go to college for four years each.
- starting my own business in the next five years.
- buying a vacation home on Cape Cod.
- preparing to care for my parents if they need help.
For the second part of the question, we will use the example of funding a
retirement. Figuring out how much money you will need includes considering
the following things:
- When will retirement begin and how long will it last? (Hint: a 62-year old
married couple today can expect at least one spouse to live to 92).
- What will my retirement income be? What do I need it to be?
- What are my current savings and which of those will be available for my
retirement?
- What are my expectations for inflation?
Once you answer these questions, determine - or have your financial advisor
determine - what diversified investment portfolio might help you reach your
goals suitably. Could real estate fit into that portfolio? Quite possibly,
yes. But how?
Real estate is just one investment type, or asset class, out of dozens.
Examples of other asset classes include cash, large, US-based company stock,
and long-term, high quality municipal bonds. Successful investment portfolios,
with success defined as investment portfolios that meet their owners' needs,
become so through diversification - a commonly used and misused term.
Imagine two investors. Each has a portfolio. Each portfolio has identical
average annual returns. The investor whose portfolio has the smoothest ride -
the smallest ups and downs, the lowest volatility - almost always has the most
money in the end. Diversification is the technique that provides that smooth
ride. The secret is to hold investments that behave differently from each
other. That is, while some investments may be losing value, others are
gaining. No investment is ever guaranteed to go up in value. No investment
guarantees a particular yield or return. Even a diversified portfolio can
lose value. If you don't believe that, as a group, investments increase in
value over time, you may be better off not investing at all.
So what about real estate? Many stock asset classes, such as large cap U.S.
stocks, have historically behaved similarly, while real estate is an asset
class that has historically behaved differently from such commonly held
investments. So including real estate as a percentage of an investment
portfolio may be a suitable way to diversify.
What types of real estate should you consider? Basically, two types of real
estate are available for investment: residential and commercial.
Residential includes single-family homes, multi-families, residentially zoned
undeveloped land, and apartment buildings (Your own home doesn't count. Even
though it may be your most valuable asset, you are probably better off
assuming that if you need money during retirement you won't be selling your
kitchen).
Commercial includes office buildings, warehouses and distribution centers,
shopping centers, and commercially zoned undeveloped land. Each real estate
sector carries its own advantages and disadvantages. Some offer income, some
capital growth, some both.
Investing directly in commercial property can be cost prohibitive. However, it
can be accomplished through other investment vehicles. Often, businesses will
form as real estate partnerships, operating companies or real estate
investment trusts, also known as REITs (pronounced reets). These businesses
offer shares publicly to investors or privately through intermediaries. Though
these vehicles often have investment minimums and certainly have risk, the
minimums tend to be less burdensome then buying a property directly, and they
offer the opportunity to gain some of the benefits of owning real property.
These real estate investments typically focus on a particular sector, e.g.
office buildings or warehouses, and give the investor exposure to that sector
with some level of diversification within that sub-asset class. For example, a
REIT that owns office buildings exclusively likely will own many. And it may
own office buildings in different regions of the country (or world) so, as was
the case in the late 1980s, the Midwest may be booming while the Northeast is
busting. The REIT's investors get the benefit of that diversification.
Investing directly in residential property, including foreclosures, is
typically less expensive than buying commercial property. But this market can
be challenging, so it's important to learn what to expect - and expect the
unexpected in many cases.
Foreclosed properties offer a unique challenge because buyers are often not
allowed into the home before making a bid. This can make it difficult to
determine the financial consequences of these investments. You may bid
$200,000 on a property and win it, only to discover that it requires $100,000
in work to be suitable for you to live in, rent out or resell. Doing as much
homework as possible before investing in foreclosures and being prepared to
spend more than the purchase price makes sense financially.
Be prepared to ask yourself:
- Am I going to live in the property or rent it?
- If I'm going to rent it, am I prepared to deal with maintaining the property
(or hiring somebody to maintain it), keeping it occupied, and collecting rent?
- Am I going to keep the property or hope to sell it at a gain?
- Is my tax advisor equipped to help me deal with the complex federal tax laws
related to real estate income and sales? (see the February, 2005 Newsletter
for thoughts on tax issues)
- Will I own the property as an individual or will I form a business (or a
trust) to own it?
- Will I own it myself or with partners?
- Should the real estate be held in my IRA? This option is often possible and
sometimes advantageous but be careful of the many restrictions.
Be aware that real estate investing - however you approach it - requires more
than just writing a check and waiting for the investment to grow. As with any
opportunity to make money, there is an opportunity to lose money.
Real estate does not increase in value every single year; despite the beliefs
of many who incorrectly project the increasing value on their home onto the
real estate market at large. The investment that offers the greatest potential
for return also carries the greatest risks.
However, if your financial planning exercise determines that you need high
returns to achieve your goals and you are willing and prepared to take on that
risk, investing directly in real estate, including foreclosures, may be
appropriate.
Whatever your decision with real estate and investing, always remember to keep
the big picture in mind. How will this investment help me achieve my most
important goals?
Christopher P. Gullotti, MSFP is a financial advisor with Canby Financial Advisors, LLC of Natick, MA
(www.canbyfinancial.com).
He has been published in the Journal of Financial Planning, appeared on local
television, and lectured at local colleges on a variety of financial topics. Canby Financial Advisors is an
independent financial planning and investment advisory firm. Securities and some advisory services offered
through Commonwealth Financial Network, member NASD, SIPC, Boston Stock Exchange. He can be reached at (508)
655-5355 or cgullotti@canbyfinancial.com.
Did you like this article? You May Also Like:
 |
Interview with the Expert: Strategies for Building Your Real Estate Network
Cathy Toomey, Broker / Owner, Stone Ridge Properties
Real estate agents are often the first people homeowners call before their home goes into foreclosure. In this interview, Cathy Toomey, a real estate broker, tells you how to build a solid network of real estate professionals - and how to use this network to find homeowners "motivated to sell."
|
 |
Nothing Succeeds Like Success: Jeremy Cyrier
Jeremy Cyrier, The Cyrier Sales Team
After learning that he netted $60k on a house he owned for just six weeks, we wasted no time in scheduling an interview with Jeremy Cyrier. Read our interview and find out what he's done to be so successful.
|
 |
Success Strategies: Negative Amortization - Useful Tool or Risky Tactic - or Both?!
Trish Signet, Loan Officer, Summit Mortgage
With interest rates rising steadily over the last few years, it's become harder for property investors and others to make the numbers work. Negative Amortization mortgages may offer an alternative, but as Trish explains, buyer beware.
|
 |
Nothing Succeeds Like Success: Brian Jones Reveals His Marketing Strategies
Brian Jones
Looking for new ways to market yourself as a real estate investor? Brian Jones, who closed five deals in 2006, shares some of his strategies - including classified advertising and contacting junk removal companies!
|
 |
ForeclosuresMass Tips: Maximizing the ForeclosuresMass Website
Jeremy B. Shapiro, ForeclosuresMass, Corp.
"There are 142 NEW Foreclosures in your counties!" Each week, a message similar to this one appears in your inbox, notifying you of all the new foreclosures that have started in your counties. With so many new foreclosures filed each week, knowing what to do with them is as critical as knowing that there are new foreclosures...
|
 |
Nothing Succeeds Like Success: Jennifer Wilson
Jennifer Wilson
In just 4 short years, Jennifer Wilson has grown her real estate investment practice from a standing start to one which expects to buy and sell 25 properties in 2006. ForeclosuresMass sat down with Jennifer to understand what's worked - and what hasn't - in her quick rise to the top!
|
 |
Negotiation Skills: Developing Strong Relationships... A Key to Success with your Contractors
Richard Cohen, Negotiation Coach and Consultant
As a property investor, you're challenged by the sheer number of contractors with whom you must negotiate. It can be a struggle, but as Richard Cohen explains, it doesn't have to be. Build strong relationships with these folks and watch your negotiations go smoothly.
|
 |
Interview with the Expert: Don't Let Mold Become *Your* Problem
Steve Goselin, EnviroTech Clean Air, Inc.
Finding mold in a building can literally bring a real estate deal to a crashing halt. No matter how much or how little mold there is, as the seller you’re responsible for clean up – or selling the property “as is” with full disclosure. In his article, mold remediation expert Steve Goselin explains why mold is causing problems in the real estate industry and what you can do to ensure it doesn’t become your problem.
|
 |
Success Strategies: Blogging for Real Estate... A Primer for Starting a Blog
Ted Demopoulos
Blogging has definitely hit the mainstream - and with over 750 real estate blogs at last count - it's time you consider starting a blog if you haven't done so already. In his article, author and blogging expert Ted Demopoulos gives you his three success strategies for starting and maintaining a blog. The key takeaway: become familiar with the blogosphere and get to know other real estate bloggers before you jump in feet first.
|
 |
Feature Article: Keep Your Title Clean: Three Strategies for Preventing Title Problems
Jacqueline Fitzgerald-Boyd
Did you know you can create some serious Title problems when you transfer Title on your own? And, did you know that a Title problem can sometimes exist for more than 20 or 30 years without ever being found - and then bang, one day this hidden ticking time bomb becomes your major Title headache? It's true. Title expert Jacqueline Fitzgerald-Boyd talks about common Title issues and how you can alleviate them. (Hint: Title is more than simply a piece of paper.)
|