If real estate seems to be draped in a fog right now, financial advisors say that for baby boomers looking at this piece of their portfolio, there is one reason to hold it that will burn away the gloom: diversification.
Nearly all financial advisors contacted by National Underwriter say diversification is critical in reducing volatility and increasing return in portfolios and that if the right approach is taken, boomers will benefit from holding it.
Cathy Pareto, a partner and senior financial advisor with Investor Solutions, Coconut Grove, Fla., says her firm accesses the real estate market for clients by using mutual funds that invest in real estate investment trusts. Those REITS, she adds, invest in commercial property that can include apartment buildings and shopping centers as well as international real estate. Mutual fund REITS give clients inexpensive access to real estate, she says.
Pareto says her firm does not time real estate in down markets. The real challenge for boomers, she adds, is controlling volatility in a portfolio and the impact that it can have on wealth. Reducing volatility can increase the rate of return, Pareto continues.
The international piece of the REIT portfolio is focused on developed countries such as the United Kingdom and Japan rather than on emerging markets, she says. The reason, according to Pareto, is that her firm does not want a client's portfolio exposed to the risk of property seizure in some parts of the world.
Expertise in real estate is advisable if a client is determined to have an actual investment in real estate, she adds. And, if a client already has other investments such as a warehouse or farm, which several of her clients have, then they probably already have a big enough part of their portfolio in real estate, Pareto says.
The important thing for boomers is to maintain liquidity in case of a crisis such as a medical problem, she continues.
Real estate has been a 5%-20% of his clients' portfolios since 2001, says Peter Canniff, founder and principal with Advanced Portfolio Design, Nashua, N.H. But this year, Canniff says he has backed out of U.S. real estate and has moved to global and foreign real estate mutual funds.
Canniff says he recommends global real estate funds and adds that there is a competitive field of open and closed-end funds as well as exchange traded funds from which to choose.
For most people, he explains, it is best to buy a real estate mutual fund in their IRA or in their variable annuity or life insurance accounts. Many real estate investments, he explains, produce ordinary income that is taxed at the client's highest tax bracket, so "it's a little bit smarter if you shelter these in your IRA or Roth IRA."
Other types of real estate investments such as REITs and limited partnerships become more complex, Canniff continues. Some trade on exchanges every day, and some may not trade at all and you're stuck with them for 5 or 10 or 20 years, according to Canniff. The most complex real estate investing is starting your own real estate project like buying commercial or residential properties and becoming a landlord, or buying land and developing it for lease or sale, he adds.
There can be some very complex and advantageous issues like tax credit investing for low income housing and some passive income tricks that should be discussed with a CPA when investing directly in real estate (as opposed to buying into a mutual fund), Canniff explains. There are some complex prohibitions around investing in real estate in an IRA if you have decision-making power over the property, he adds.
The real estate market in the U.S. has seen quite a run up over the last decade and it appears the U.S. residential market is in for a slowdown, he says, adding that commercial real estate could follow if the business/economic cycle goes into a contraction. When the stock market has an extended decline, a recovery can often take 2 or 3 years or more. The real estate cycle tends to be longer than that so you may need to wait 3 to 10 years for a full recovery, Canniff says.
