Real estate allows for growth
By Russ Wiles
The Arizona Republic
One of the surprising things about the economic softness is just how resilient housing has been.
Q. A middle-aged couple with a portfolio built mainly of stocks and bonds wonders if they should add real estate or other tangible investments. They own a home, but is this enough? A. Alan Rosenfield, a money manager at Expansion Funds America in Phoenix, is among advisers who think investors should have real estate positions beyond what's in their homes. Property prices don't move in lockstep with the broad stock market, providing benefits of diversification. "That's one reason we like it," he said. Yet Rosenfield says real estate comes with various drawbacks, depending on how you own it, such as generally low liquidity if held directly. He argues most investors shouldn't put more than 25 percent to 35 percent of their portfolios into REITs, real estate mutual funds, direct properties and the like. Another tangible investment Rosenfield thinks deserves attention is gold, which can be held as bullion, via gold-mining stocks and gold mutual funds, and in other ways. The metal has been hot lately, owing to war jitters, concerns about the strength of the dollar and more. Rosenfield sees gold also as playing a role in many portfolios but recommends a lower weighting than with real estate — 10 percent, maximum, for most people. • More information For information on real estate stocks and a listing of real estate mutual funds, see the Web site run by the National Association of Real Estate Investment Trusts, www.nareit.com, or call (800) 3NAREIT.
The stock market has shed roughly $7 trillion over the past three years, and jobs have been lost. But through it all, home prices continue to rise, driven in large part by rock-bottom interest rates.
How much to invest?
"If it weren't for housing wealth and cash flow from it, the economy would be in much worse shape," said Sung Won Sohn, chief economist at Wells Fargo & Co. in Minneapolis. "A lot of people are actually better off than a few years ago."
The typical household has more than three times more wealth tied up in housing than stocks, Sohn said, and more people are homeowners than stockholders. Favorable real estate trends can offset much of the damage on Wall Street.
But all this raises a question of whether your home should be considered part of your investment portfolio. Housing equity and debt certainly count on personal balance sheets, but wealth locked up in a home isn't easily spent unless you cash out and move to smaller quarters or take out larger loans on the property, a potentially risky strategy.
"I don't see my home as an investment," said Jeff Young, a Scottsdale financial adviser who also owns six rental properties. Owner-occupied dwellings are best viewed as liabilities, he argues, since you must keep making payments on them.
Besides, a single home won't provide much diversification. Nor can it be liquidated fast to meet emergencies. And the high transaction costs to buy and sell are another hurdle.
But even if you exclude owner-occupied housing, there are solid ways to gain investment exposure to real estate. One increasingly popular avenue is through real estate stocks and mutual funds.
Real estate investment trusts, or REITs, are special companies that pass most earnings through to shareholders. With a REIT, investors get fairly high dividend yields (about 7 percent currently), professional management and a diversified mix of properties. REIT shares trade in the stock market but often move against the broad market's trend.
Real estate funds, which invest in dozens of REITs, take the diversification argument further. They're offered through financial planners, brokerages and directly via investment firms such as Vanguard, Fidelity, USAA, T. Rowe Price and Cohen & Steers.
Compared with direct property ownership, REITs and real estate funds feature low transaction costs and high liquidity. And they're much more affordable, with minimum investments of just a few thousand dollars, if not less.
But direct ownership has benefits, too. Tax laws allow for the deduction of mortgage interest and many other expenses, including depreciation. Plus, taxes on capital gains can be deferred until the home is sold — and even longer if the proceeds are reinvested in another property through a so-called 1031 exchange.
Also, single-family housing historically has generated decent gains with moderate volatility.
Usually, housing fares better than that.
There has been talk of a real estate bubble developing. But if prices soften anywhere, they would likely start in hyperinflated areas like San Francisco and Boston, Sohn believes.
Because most people purchase homes using some borrowed money, this leverage boosts their investment returns. In the case of rentals, landlords rely on other people, the renters, to buy their properties for them.
With rental property, direct ownership also offers greater control than with REITs and funds, although that's a mixed blessing.
Direct ownership can be rewarding. But it's not on the same plane as stocks, bonds and other "hands-off" investments, including REITs.
"With a stock, the most you can lose is the value of your investment," Young said. "But with a rental home, you can be sued, lose more than your investment and even go to jail."
