Is Real Estate Investing Right for You?

Clients of Daner Wealth often ask whether they should invest in real estate.  We typically reframe this inquiry to address these issues:

1.  Should you invest more of your assets in real estate?

2.  If so, how much of your total assets should be invested in real estate?

3.  What role does liquidity play in your investment decision?

The first step

Before deciding whether to invest in real estate, calculate how much real estate you already own.

Do you own a home?  The market value of that home is a real estate investment. However, some experts don’t believe you should consider it a real estate “investment” because you are using it for shelter, unlike other investments unrelated to your personal life.

Do you own investments that track common indexes like the S&P 500 index?  You should know that 2.6% of the S&P 500 is invested in real estate.

How much of your portfolio should be invested in real estate?

A reasonable range of the amount of real estate that should be part of your portfolio is 5%-10%, but every situation is unique, so this is an issue you should discuss with your financial advisor.

Others, like David Swensen, formerly the head of Yale University’s endowment, recommended an allocation as high as 20% of your assets.

Why include real estate?

A broadly diversified portfolio allocates to many sectors, like information technology, health care, energy, and industrials.

Real estate is no different.  Adding it to your portfolio mitigates risk because the returns of other sectors may not be correlated, providing you with some downside protection.

According to Fidelity, in addition to managing risk, “sector investing” exposes you to different segments of the economy and can help pursue growth and diversification.

Liquid or non-liquid investments

Before deciding to take the plunge into real estate investments, it’s important to understand the difference between liquid and non-liquid investments.

A liquid investment is one that can be converted to cash quickly without impacting the value of the investment.

Holding cash in a checking or savings account would be an example of a liquid investment.

Non-liquid investments are difficult to convert to cash quickly without the potential for losing value.

Your home is a non-liquid asset.  Stocks are also non-liquid because even though they may be able to be sold quickly, you may have to dispose of them when they have declined in value.

Investors in illiquid assets may expect higher returns (called a  “liquidity premium”) to compensate them for taking the additional risks of holding assets that cannot quickly and easily be converted to cash without losing value.

While you may hold both liquid and non-liquid assets in your portfolio, you want to be sure you have sufficient liquid assets to meet emergencies without having to sell non-liquid holdings at a loss.

Real estate and liquidity

Real estate is generally considered illiquid because it can’t be sold quickly without risking a loss.

However, some real estate investments are more liquid than others.

While still illiquid, investing in a real estate investment trust (REIT) is no different than buying any other stock.

A REIT is a company that owns and manages real estate that generates an income.  A REIT is often publicly traded, making them more liquid than owning physical property.

REITS typically own apartment buildings, office complexes, retail centers, and warehouses.

You can learn more about the different types of REITS here.

Other types of real estate investments include:

• Owning rental properties;

• Participating in a real estate investment group;

• Flipping houses;

• Using online real estate platforms like Fundrise, CrowdStreet, and PeerStreet (among many others).

Cons and pros

Depending on the type of real estate investment you choose, there are different cons and pros.

Let’s start with the negatives.

We’ve discussed the lack of liquidity.  If you need quick access to your funds, don’t tie up your money in real estate.

High cash requirements may be another negative.  Banks may insist on a large down payment, depending on the property type and location and your financial situation.

If you decide to invest in rental properties and manage them yourself, plan on spending time dealing with tenants and maintenance issues.

There are many benefits to investing in real estate, which include the following:

• Potential appreciation of property;

• Possible positive cash flow;

• Increase in equity over time;

• Tax benefits, including potential capital gains when you sell and taking a depreciation deduction while holding the investment;

• Potential protection against inflation;

• Diversification of your portfolio.

Whether to invest in real estate — and how to do so — is a complex decision that involves consideration of your financial situation, your goals, your time horizon, your ability to deal with illiquidity, and your available time.

At Daner Wealth, we help our clients manage their investments and consider their overall financial situation before recommending investing in real estate or any other sector.