The Reality Of Real Estate

Stocks and bonds are good, but real wealth comes from owning  property.  Or so my father always claimed.  Of course, he grew up on a cotton farm where the more land you had, the more cotton you could plant and the more money you could supposedly make.  But some years the price of cottonseed and equipment repair and extra hands to pick the cotton ate up all that extra money.  Later in his life, whenever  he got on his property high horse, I occasionally had to remind him that he fled the family farm at 18, anxious to find an easier way to make a living.  The Reality of Real Estate

The same principle applies today.  REITs aside, owning real estate is generally hard work.  (Mind you, having 10-15% of your overall asset allocation in real estate is prudent, as it can provide needed diversification from stocks and bonds.) BUT, if you are counting your primary residence as your “investment” in real estate, think again.

Why Is A House Just A Home?

For years, we all assumed that our houses would appreciate at a rate sufficient to:

a) qualify us for a home equity line to pay for our kid’s college education;

b) fund a luxurious retirement;

c) pay for a well-managed assisted living facility in our old age &

d) provide a fat inheritance for our kids.

If you are still operating under this assumption, pinch yourself.  Hard.  If you stay in your house 30 years, pay off the mortgage and sell in a decent market, history says you may average a return of 3% per year on your investment.    And that doesn’t include all the cash you sunk into your personal money pit over those 30 years to make it a home.

So, now that we’ve got THAT out of the way,  how can you make sure you do have some real estate exposure in your portfolio?

Here are your choices and why some might be better for you than others:

Buy  A Vacation Home:

See my comments above re: your primary residence and multiply x 2.  Many second or vacation homes are in locations that become popular, spark a building boom, rise in price and then crater (or at least soften). This last quarter, housing prices in Orlando were down 24%, Phoenix 22% and Denver 14%.    This is not to say buying a vacation home is bad, just make sure you understand WHY you are buying it and don’t be fooled with the idea that you are buying into an about-to-be-discovered hot spot and will make a gazillion dollars on the “investment”.

An excellent guide if you are intent on buying a vacation  home is The Second Home by Jeff Haden.

Buy A  Rental Property:

This can be an excellent source of secondary income.  Rental receipts have smoothed out cash flow for many a retiree.  My caution here is twofold:  1. Again, don’t buy it for an increase in property value – think of it like a bond paying regular monthly interest in the form of rent; and  2. This is an ACTIVE investment.  YOU ARE A LANDLORD.  Which means you can be called in the middle of the night when the pipes break or you can pay someone else to take that call, which eats into your cash flow from the rent.   Owning rental property is a second job.  And what happens if your tenant leaves on short notice and you go a month or two without that expected  income?  Worse, what if your crazy tenant doesn’t leave, even when you threaten eviction?    See Rental Property Questions and the Rental Property Checklist at www.financiallyfitafter40.com for all the questions you should ask yourself before you buy rental property.

Need help with running the numbers?  Get Real Estate Math Demystified by Steven P Mooney.

Buy Land:

Land’s not such a bad thing to own if you plan to develop it, sell it to a developer or build on it yourself one day.  If you are going to develop it in the future, you better find out now about easements, access to sewer & water,  road access, any deed restrictions or environmental hazards.  The list goes on…. Just know that appreciation of raw land is even more uncertain in these economic times and you may have difficulty selling it if you need the cash.  I know people who have had land “on the market” for years…

Buy Into A  Real Estate Investment Trust:

Real Estate Investment Trusts (REITs) are a good way to invest in real estate without coming up with large amounts of money.  They are basically publicly traded companies that invest in a variety of real estate ventures, such as shopping centers, hotels, office buildings, apartments, etc.  They trade on the stock market, so they are very liquid.   They, too can be a great source of income, as they are required to pay out 90% of their taxable income each year.  Again, I wouldn’t hold more than 10% of your total assets in any one REIT.   Here’s a great link to seeing performance information for the largest REITs on Forbes.com: http://tiny.cc/EVIZM.

Buy A  Real Estate Mutual Fund:

This is the easiest way to build real estate exposure into your asset mix.  It gives you the most diversification, is professionally managed and you can liquidate it any business day.   There are some excellent funds out there, including AIM Real Estate Fund, a 5 star Morningstar fund year after year.

However you decide to own real estate, just remember:  You can’t buy lunch with a fistful  of dirt…

Photo by:  Martin LaBar

About the author

Lea Ann Knight, CFP®

Lea Ann is the Principal of Garrison/Knight Financial Planning as well as the creator of the financial literacy site, Financially Fit After 40. She also writes a monthly column as the Money Expert for All You Magazine.

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