Imagine yourself 10 times wealthier than you are now. Are you living the good life on a beach, maybe the golf course or with friends and family? Now consider how you made enough money to achieve this life, and outside of an inheritance, its likely one of three possibilities:
- You created a business
- You made a lot of money in stocks
- You made a lot of money in real estate
In traditional investment circles, real estate is either championed as a must-have wealth creation vehicle or it’s an afterthought. Few organizations take a balanced approach, which is often why many people don’t give it much attention when planning for retirement. However, real estate shouldn’t be overlooked, even if you remain scorned from the 2008–2009 housing market bust.
If you’re interested in real estate as a wealth building tool, one of the most important questions you must ask yourself is whether you have the time to commit to an active real estate strategy or if you only have capacity for a passive approach (meaning someone else manages everything, or most everything, for a fee).
Common active approaches to real estate investing include “house flipping” or commercial property and running a business. Individuals who are looking for a passive strategy could look into either public or private Real Estate Investment Trusts (REITs) or institutional private equity real estate funds. Owning rental real estate investments (residential, commercial or a vacation home) could be either active or passive, depending on your preference.
Opportunities for Real Estate as an Investment Strategy
It’s important to note that investing in real estate to build wealth as part of your retirement plan can offer several advantages not found in portfolios made up exclusively of stocks and bonds, such as:
1. Potential High Returns
For many people, the key benefit of real estate as an investment is that it’s generally an asset class with high returns. The National Council of Real Estate Investment Fiduciaries reports that, as of May 9, 2019, over the previous 25 years the average annual return for private commercial real estate properties held for investment purposes was 9.4%. Over the same period, the North American Real Estate Investment Trust Index of publicly traded REITs returned 10.33%.
Real estate gives you the opportunity to build wealth and sometimes quickly thanks to the ability to borrow money to purchase real estate—but it’s not risk-free (as many investors learned when the housing bubble burst in 2008–09) and the buy decision is paramount when it comes to real estate investing. This is particularly true of private real estate investment, as the assets require time to liquidate and investors should be compensated with higher returns for taking on the illiquidity risk.
Depending on your goals and investments, you could have the advantage of enjoying an income stream (from rent) and/or seeing your asset grow in value. Plus, unlike some other income-producing investments that typically pay a fixed percentage (like bonds or CDs), you could potentially have periodic increases in the amount of revenue your properties produce as rental prices increase. But keep in mind that, although added income is nice, you will have costs associated with flipping the property, maintaining the property and/or hiring a property management company to help.
Remember: real estate requires a lot of research. It's not something you can go into casually and expect immediate results and returns. Real estate is often not an asset that's easily liquidated.
2. Limit Impact of Inflation
If you were alive in the 1970s or early 80s, you likely understand the insidious nature of inflation and the reduction in buying power that can occur when inflation runs at elevated levels. Owning a strong business (via stock ownership) can often mean the business can adjust their prices to offset inflation, but not all businesses have this ability and will often be forced to absorb some costs amid spikes in inflation.
Therefore, investors often want a more explicit hedge against inflationary spikes, particularly as the world’s debt levels continue to rise rapidly. Dedicated inflation hedges typically involve investing in real assets. Real assets are generally expected to maintain or increase value relative to the reported inflation rates within an economy and include real estate, because property values and rents typically increase over time at or above the rate of inflation. For instance, average sale prices for new homes have appreciated between 3% and 5% annually historically (although that rate varies by location). Thus, there is ample evidence why real estate is often considered a strong hedge against inflation.
Real estate values can increase for a variety of reasons, such as gentrification, development of new office and shopping complexes, or the supply and demand that comes with population growth. However, there are also many reasons why your real estate investment may actually decrease in value, including increasing mortgage rates, natural disasters or foreclosures/short sales in your neighborhood. You should consider all factors relevant to your potential properties before making investment decisions.
3. Possible Tax Advantages
Real estate comes with potential tax advantages, ranging from a litany of deductions, credits and beneficial capital gains treatments and even exclusions, such as on the sale of a primary residence. In many cases, income received may be offset by a variety of these, including depreciation.
For example, another benefit was advanced for real estate owners in 2017 as part of the Tax Cuts and Jobs Act. Under section 199a of the tax code, investors may be able to deduct up to 20% on their combined qualified REIT dividends and publicly traded partnership income, assuming certain conditions are met. If you own or are considering investment properties, discuss this with your financial planner or tax professional to see if it applies to your situation.
4. Portfolio Diversification
Different asset classes react differently to various market environments. Stocks and bonds, for example, often have a low correlation to each other: when one is performing well, the other isn’t. When stocks are down, bonds are stable or up, and vice versa. Real estate, on the other hand, may be driven by a completely different set of factors causing the return pattern to differ from stocks and bonds.
All investing comes with risk, but diversifying your portfolio—through rental properties or REITs, for example—can help smooth out your investment experience over time as the peaks and valleys of other investments offset one another. This can go a long way toward helping you reach your financial goals with less risk.
Developing a real estate investment strategy can be challenging to begin with, but it requires even more care when considering how real estate could fit into your retirement strategy. Working with a financial planner can help you plan for retirement with careful consideration on how best to utilize real estate in your overall strategy.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
There is no guarantee that a diversified portfolio will enhance overall returns or out-perform a non-diversified portfolio. Diversification does not protect against market risk.
Investing in Real Estate Investment Trusts (REITs) involves special risks such as potential illiquidity and may not be suitable for all investors. There is no assurance that the investment objectives of this program will be attained.
CFP® Larry knew from a young age that he had a passion for finances, investing and helping others. With more than 30 years of experience in the industry, his approach to financial planning includes an emphasis on building relationships with clients while working to help them achieve their goals. As one of the four founders of Summit Planning Group, Larry joined Wealth Enhancement Group in 2019. He and his wife Sue have three children. His family is actively involved in the community,...Read More