A lot of investors (and their financial advisors) may be hesitant to get into real estate investment. The reason is because they don’t have full confidence in what they are doing. So much of long-term wealth management is about minimizing risk—or avoiding it altogether—so why dive into an investment pool you are not completely comfortable with?
As we’ve outlined in several Illumination Wealth Blog articles this month, investing in real estate can be a fantastic and synergistic financial strategy when done right. It can generate cash flow free from taxation now while also appreciating in value over time. Many savvy real estate investors are able to achieve the financial independence they seek while also planning for an early retirement.
Many people avoid investing in real estate because they assume it will require a lot of work and create a lot of headaches. This may be true for active real estate investors who take a hands-on approach to buying properties, renovating them, renting them out and/or “flipping” them for profit. However, many investors prefer to take a hands-off approach that eliminates the headaches.
You can choose to invest directly in real estate through a private real estate investment fund or limited partnership. This is an investment that is not exchanged traded like stocks and thus not subject to the same levels of market volatility. This can be accomplished through relationships with these firms, your financial advisor and even through crowdfunding websites. In these situations, you contribute your capital and receive your cash flow distributions without having to do all the dirty work of identifying, acquiring, improving and managing the properties. You will want to do your research on any investment group you consider joining to make sure it’s the right fit for you (we will discuss the key due diligence items in a future post) and that have the proper business plan in place for the potential investment.
Why you should consider investing in real estate as part of your financial plan boils down to four primary benefits that you won’t find with traditional stocks and bonds:
1. Tax Efficiency
Tax laws are very lenient and beneficial when it comes to real estate ownership. If you are earning income in the form of rent, much of the tax burden can be shielded by depreciation. In some cases the depreciation from one investment can offset the passive taxable income from other real estate investments providing tax free cash flow. When the property is sold, capital gains taxes can be deferred into the future via a 1031 exchange, but capital gains rates are more favorable compared to ordinary income tax rates. You’ll want to talk with your financial advisor or tax planner to make sure you are doing everything right to get the most tax benefits out of any real estate investments you make.
2. Absolute Returns
Private real estate investment is proven to generate high absolute returns when you factor in capital appreciation, debt pay-down and income that is earned over time. Of course, you must be smart with your real estate investments and how they are managed. It’s also not wise to hold onto underperforming properties. A good financial advisor will be able to help you identify the best opportunities and manage your real estate portfolio for the best results.
3. Less Volatility
Though real estate is very cyclical over time, it’s not nearly as volatile from day to day as the stock market. Since the real estate cycle is longer and slower than the stock market, you can follow trends and have more time to identify changes and make strategic decisions. In addition, a study from Metlife has shown that private real estate was one of the least volatile investments over the past 20 years despite generating stronger returns than stocks. Real estate is not impervious to market volatility. It brings its own risks as with any investment, but a smart real estate investor (with the right guidance) will be able to mitigate his or her risks with the right planning and timing.
Adding non-correlated assets to your portfolio (investments that don’t rise and fall at the same time as your other investments), is an academically proven way to increase your overall returns. Public markets provide liquidity, but that comes at the expense of peace of mind disrupting volatility. Private investments offer investors low volatility, but with that comes illiquidity.
A study by TIAA CREF showed how private real estate has minimal correlation to both U.S. stocks, bonds and REITS, as measured by the National Council of Real Estate Investment Fiduciaries (NCREIF) property index (NPI), which looks at the returns of private institutional grade commercial properties. An investment portfolio benefits greatly when it includes asset classes that are not correlated to each other. Private real estate helps investors manage the volatility in their portfolios because it is immune to the psychology driven and daily-traded financial markets.
At Illumination Wealth, we feel real estate offers great opportunities and should be considered as part of an overall financial plan. It shouldn’t be your only form of investment and some clients will feel more comfortable investing in real estate than others. We certainly understand. It’s just one part of our all-encompassing approach to financial planning that will empower you to achieve financial independence and start saving for an early retirement.
Contact Illumination Wealth to learn more about our financial services or to schedule a no-obligation consultation to discuss your wealth management goals.