By Brian Spinelli, CFP®, AIF®, Co-Chief Investment Officer
As advisors and investors in broadly diversified investment portfolios, we think real estate is an important component to consider in a strategy.
In this article, I’ll spark the conversation with fundamental pros and cons. I’ll follow up next month with a piece that focuses more deeply on key questions to consider if real estate investing is a central element of your investing-for-retirement strategy.
We are always happy to discuss your investment objectives with you in more depth. We do generally consider income-generating real estate as a part of diversified portfolios to complement ownership in a home, which is a different type of real estate exposure.
Real estate is a massive asset class
There is a very old investment saying, “Buy land – They’re not making any more of it.” If only it was that simple. There’s a lot of unused land that probably doesn’t have much investment value. Look down the next time you’re on an airplane flying over an uninhabited desert. What really drives the value of real estate is access and location, scarcity of available space in areas where people want and need to be, and the income and appreciation as a result of this economic activity.
For example, an apartment building in a high demand location in a major metropolitan area probably has a higher value and higher rents than if it were placed in a hard to get to and smaller populated area. While there is a finite amount of land on this planet, it’s not all developable and in demand.
Something interesting to me is how much attention the U.S. stock market gets daily in the news, yet it is a mere fraction of global assets. Let’s use the S&P 500 index in this case to discuss U.S. stocks. It doesn’t cover every company that publicly trades, but as of May 31, 2023, it covered about $37 trillion U.S. dollars of value. As a comparison, privately held real estate globally is estimated to be worth north of $300 trillion U.S. dollars. I suspect private real estate doesn’t get daily attention because values don’t change minute to minute and talking about rental checks showing up monthly doesn’t need a lot of airtime.
Pros of investing in real estate
Cash Flow – Rental real estate can generate consistent monthly cash flow, which can serve as a source of income in retirement or supplement income while you are working. I like the term mailbox money because rental income shows up in the mailbox, usually monthly. In order to be a benefit, the rents coming in have to be larger than the expenses of maintaining a property in order for this to be a positive benefit for cash flow purposes. Aside from appreciation (addressed next), getting to a critical positive cash flow level is how some people have managed to retire earlier from their day jobs.
Appreciation Potential – Appreciation is important if you will need/want to sell in the future or borrow against the property to continue to expand into more rental locations. At a minimum, the appreciation should keep pace with inflation to protect purchasing power over many years of ownership.
Diversification – Historically and over longer periods of time, real estate serves as a diversifier to traditional stock and bond investments. Private direct real estate that doesn’t trade on public exchanges tends to be less correlated with assets that change value daily. We all know that properties are not traded minute to minute – their value changes are much slower.
Real estate is also an important global asset as I mentioned above. It should be a consideration for a personal balance sheet. It commands such a large part of global wealth – which makes it quite difficult to actively avoid when using a diversified investment approach.
Tax Benefits – Real estate comes with some added tax benefits that you cannot gain with only owning stocks and bonds. You may be able to deduct mortgage interest, property taxes, depreciation, and other expenses, which can reduce your overall tax liability. While this is a benefit, certain deductions such as depreciation might come back to surprise an investor if they sell the property after many years of holding it.
Cons of investing in real estate
Illiquidity – Real estate investments are relatively illiquid compared to publicly traded stocks or bonds. If you or someone you know has ever sold their home, this is an example of illiquidity. Yes, you might see some transactions close in a matter of a few weeks, but it’s not something that can be done in a single day. Illiquidity isn’t necessarily a bad thing, and some assets should not be transacted in a matter of minutes. You might need days and weeks to get a realistic offer and not be forced to take a low-ball first offer.
Initial Capital Requirement – Investing in real estate usually requires a significant sum for a downpayment. This can be a challenge for an individual to come up with on their own and may be a barrier to entry. However, there are ways to invest in diversified pools of physical real estate without necessarily requiring large amounts of capital to own a portion. Still, capital requirements are a hurdle if you are trying to source a physical property on your own.
Property Management – This might be the most common issue we hear about from clients who own rental properties. Rental properties involve some level of active management, including finding tenants, property maintenance, dealing with repairs, and addressing tenant issues at any time of day. This can be time-consuming and quite inconvenient – and may require additional resources such as hiring professional property management services if you do not want to do this yourself.
Market Volatility and Risk – Most investments have some element of risk: The value of your investment can fall or fluctuate meaningfully in price. Real estate markets are not immune and do experience periods of volatility and downturns. Economic factors, such as interest rates, unemployment rates, and local market conditions, can significantly impact property values and rental demand. While positive cash flow is a positive aspect, losing renters and not being able to fill the vacancy within a reasonable period of time can get investors into financial trouble.
Regulatory and Legal Considerations – Like most investments, there are legal and regulatory matters that cannot be ignored. A practicing real estate attorney can be a good resource to help an investor navigate these areas. Real estate investments are subject to laws, regulations, and local ordinances. Landlord-tenant laws (e.g. lease agreements), zoning regulations, building codes, and other legal considerations can create additional complexities and responsibilities for real estate investors. Another aspect to consider is being properly insured for potential catastrophic losses (e.g. fire) and/or liability issues (i.e. tenant lawsuits) that arise.
Real Estate is a fascinating asset and investment. While the pros and cons of investing in real estate discussed here definitely are not an exhaustive list, hopefully they will help you get started if you’re considering it for your investment strategy. Real Estate is tangible and observable as you go about your daily routine and takes up such a large amount of assets globally, making it hard to ignore. In the follow-on article, we’ll narrow the discussion down to how this asset class may play into a retirement strategy and the points investors should consider if pursuing this path. Learn more about our investment services.
Disclaimer:
Halbert Hargrove Global Advisors, LLC (“HH”) is an SEC registered investment adviser located in Long Beach, California. Registration does not imply a certain level of skill or training. Additional information about HH, including our registration status, fees, and services can be found at www.halberthargrove.com. This blog is provided for informational purposes only and should not be construed as personalized investment advice. It should not be construed as a solicitation to offer personal securities transactions or provide personalized investment advice. The information provided does not constitute any legal, tax or accounting advice. We recommend that you seek the advice of a qualified attorney and accountant.
