Unlike the dollar, the government can’t print real estate; so, I’ve been a long proponent of real estate investing. But, then, I’m also a proponent for investing in stocks. I also like commodities. What do they all have in common? They all have had their ups and downs.
There have been times when people have made money – or been hurt – in all of them. That’s why we diversify. You see, you don’t diversify investments; you diversify risk!
Because the real estate market is composed of non-interchangeable, unique, illiquid properties, it might be considered as less efficient than the stock and bond markets; but, that inefficiency is probably what creates exploitable opportunities for skilled investors. But, because each investment is unique and non-liquid, it’s important that real estate investments be adequately diversified.
You can diversify your real estate portfolio by having ownership interests in different types of real estate, such as:
- Office buildings
- Residential apartment complexes
- Shopping centers
And, you can diversify geographically, as well.
Want to buy an apartment building? You can, but you might consider this: You wouldn’t be purchasing an `investment’ as much as you’d really be buying a full-time business. If you tie all your money up in that one business, you’re putting all your eggs in one basket, hoping the equity will be there when the day comes you actually need it. In essence, it’s like putting all your money in one company’s stock!
As recent history has shown, that can be problematic. Equity real estate investment trusts (REITs) can provide an alternative method to provide real estate diversification. Equity REITs are publicly traded operating companies that own and manage real estate properties. Similar to mutual funds, equity REITs serve as a conduit for earnings on investments and avoid corporate taxation by meeting certain investment and income distribution requirements.
One of the reasons many investors include REITs in their portfolios as a diversification tool is because they’ve offered long-term total returns comparable to the stock market – dividend income has been a major portion of that return – and equity REITs have had a relatively low correlation with both the U.S. bond and stock markets. There are also some non-traded REITs that can offer relatively consistent income streams for those willing to sacrifice liquidity on that portion of their assets.
How big of a role should real estate play in your portfolio? That’s something you should discuss with your advisor, preferably one who provides planning and investment advisory services on a fee-only basis. Making blind purchases can be risky financially; and they can be even more risky if you’re just buying from a salesman.
But, don’t fall prey to common misconceptions many investors have: Thinking their home is a real estate investment – it isn’t, it’s shelter, and you’ll always need to have one. Just like owning rental real estate directly isn’t so much an investment as it is a business. You can live off the business, but you won’t retire on it – you’ll have to sell it to retire, just like any other business.
The key is the plan: If you don’t have a formal, written financial plan for your future, you really don’t know how much real estate – or what kind – you should have. And, getting older without a plan is never a good idea.
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Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER® professional and An Accredited Investment Fiduciary® in his 21st year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California. He is also licensed for insurance as an independent agent under California license 0C00742. IFG helps specializes in crafting wealth design strategies around life goals by using a proven planning process coupled with a cost-conscious objective and non-conflicted risk management philosophy.
The Independent Financial Group does not provide legal or tax advice and nothing contained herein should be construed as securities or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.