Real estate is a crucial part of any well-diversified portfolio. Most investors own their homes, and these properties are often the largest asset in their overall net worth.
Recently, we worked with some investors who wanted to expand their real estate portfolios to include more rental properties as they approach retirement. Their current rental properties generate substantial cash flow, yielding between 6% and 8%, considerably higher than many dividend-paying stocks that yield 2% to 4%. In addition to being a great income generation tool, home values generally increase over time, providing real estate with appreciation potential. On paper, this makes real estate an incredible tool for building wealth.
However, there are challenges with investing in real estate as part of a retirement portfolio. If investors cannot act as landlords, they will need to hire a property management company, which can take 20% to 30% of the profits. This is significantly more than the fees charged by investment managers for managing a stock portfolio.
When rental properties are occupied and maintenance is seamless, everything runs smoothly with no issues or emergency calls. However, situations can turn south quickly. Landlords must be available when problems arise, even if it means cutting a vacation short. During an economic recession, finding renters may become difficult, potentially necessitating rent reductions. If tenants fail to pay, the eviction process can be arduous and time-consuming. In this light, stock dividends may appear to be a more convenient and reliable cash flow option.
Another important issue to consider is investing a sizeable portion of investable assets into a relatively illiquid asset. While real estate is a solid choice for generating income, transitioning into retirement is a phase where having liquid assets becomes a priority. Working years are an accumulation phase, and retirement is a distribution phase, so liquidity needs to be reassessed when there is no regular paycheck. Investors should carefully weigh the size of real estate in their overall portfolio, considering their home as part of their holdings. Adding more properties can quickly overweight a portfolio in illiquid assets.
To alleviate the liquidity issue, some investors may consider real estate investment trusts (REITs), companies that own and operate income-producing real estate, allowing investors to earn income from real estate without buying, managing, or financing properties themselves. Many REITs are publicly traded like stocks, making them highly liquid. Furthermore, REITs offer the benefits of geographic and property type diversification, including single-family, multi-family, commercial retail, storage, and even raw land.
The real estate market has been robust for a long time. With historically low mortgage rates, property and home prices have experienced significant appreciation. Real estate can serve as a hedge against inflation because it is backed by a physical asset. However, real estate can also be highly leveraged, so when interest rates rise, mortgage rates may become a concern.
Overall, real estate can provide a balanced mix of income, appreciation, and risk mitigation, making it a valuable component of a well-rounded investment portfolio. As with any investment, there is a balance between risk and reward. With due diligence, investors can make more informed decisions about this asset class.
If you have questions on how real estate may fit into your investment portfolio, the experts at Henssler Financial will be glad to help:
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- Email: experts@henssler.com
- Phone: 770-429-9166
Listen to the July 27, 2-024 “Henssler Money Talks” episode.
This article is for demonstrative and academic purposes and is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing.
