Why and How to Diversify with Real Estate – REITS + Real Estate Crowdfunding
Guest columnist, Joseph Hogue, CFA
Don’t let the headaches of real estate investing keep you from diversifying your portfolio into one of the best long-term assets.
Despite what you might hear on the 3am infomercials, real estate investing is hard work.
Barbara explained in an earlier post about why she gave up being a landlord decades ago because of the constant headaches.
I can relate. I started buying rental property early in my 20s. I had worked as a commercial real estate agent and wanted in on the cash returns and seemingly endless appreciation that was just getting started in 2002.
I soon realized why real estate investing is far from the passive income strategy many websites make it out to be. Have you ever been called at 5am to light someone’s pilot light on a water heater? I have…many times.
Besides the constant tenant issues, there’s also the cost of managing your own rental properties. Between regularly having to clean up a property to keep the city off my back and literally renting an industrial dumpster every time someone moved out, I wasn’t seeing the cash flow dream real estate is supposed to be.
But that doesn’t mean I’ve sworn off real estate investing. Few assets have created as much legacy wealth as property. It’s a great tax break and a must for reducing the risk in your overall wealth.
I just had to change my strategy.
Why You Still Need to Invest in Real Estate
There are three reasons why, despite all the problems, you should still invest in real estate. One of the motives is an absolute must for any investor while the other two are just good reasons.
First, real estate is a critical source of diversification for your investment portfolio. Diversification is the idea that assets-think broad investment categories like stocks and bonds-react differently to the economy and other events. When stock prices fall through the floor because of slow economic growth, bond prices generally rise and you’re not left worrying whether you’ll ever be able to retire.
Real estate values generally keep up with inflation, something that can destroy bond values. Real estate has relatively limited supply and consistent demand, which makes it less volatile than stocks.
Real estate investing also offers solid returns over the long-run. Besides property appreciation that generally rises just above inflation, real estate provides an immediate cash flow return even if much of it may be needed to pay the mortgage.
The NAREIT All Equity Index, an index of commercial real estate trusts, has provided a compound annual return of 9.9% over the three decades to June 2017. That’s well over the 6.7% annualized return on stocks in the S&P 500.
Despite a huge drop when the bubble burst in 2008, real estate has been an excellent investment.
Finally, real estate investing offers a tax break you don’t get with many other assets. Direct ownership of real estate allows you to write-off mortgage interest as an expense, lowering the profit you’re required to report for taxes. For another deduction on your taxes, you are allowed to depreciate the value of the property, even though the market value might have increased.
The combination of expenses and depreciation often means that real estate can provide a tax shield for other investment income.
How to Invest in Real Estate Without the Hassle
So if direct ownership is out of the question for all but the most committed real estate investors, how can you still get exposure to the asset class?
I like three options for real estate investing, one of which will reduce the hassle of direct ownership while the others may eliminate it completely.
- Start a Real Estate Investment Club of industry experts and investors might not make property investing completely stress-free but it will help you get answers when needed. You can join an existing club or start one by looking for real estate investors in your area. Get together enough investors and other industry experts like contractors, mortgage brokers and lawyers will join and offer their advice. Each member of the club can keep separate investments or pool their money for joint properties.
- Real Estate Investment Trusts (REITs) are a great way to get indirect ownership in real estate. These funds hold hundreds and even thousands of properties along a specific type or geographic theme. The company is professionally managed and avoids paying corporate income taxes if most of the cash flow is paid out to investors. That means you receive high dividend yields and a nearly stress-free way to invest.
- Real Estate Crowdfunding is becoming something of a middle-ground between direct ownership and REIT investing. Developers and investors apply to post their real estate project on one of the websites which verifies property and investment materials. Individual investors can browse the available projects and invest as little as $1,000 in either debt or equity. The developer manages the property and remits cash flow to the website which then deposits it into investor accounts.
I still own a couple of residential rentals but am only investing new money in REITs and in crowdfunding projects. There are disadvantages and benefits to each investing method. I still like the pride of ownership and tax breaks I get from direct ownership but love the stress-free returns of REITs. Crowdfunding is a newer opportunity but has its own advantages as well like the ability to diversify across different property types and locations easily.
Real estate investing doesn’t have to cause you to lose sleep or stress out. Different options to invest in real estate can give you exposure to an asset class that will diversify your portfolio and provide solid returns without all the hassle of traditional investing. Consult your financial advisor for how real estate investing fits with your wealth plan and consider an accountant to make sure you get all the tax benefits.
Joseph Hogue, CFA is an investment analyst and blogger. He runs five websites in personal finance, investing, making money and crowdfunding along with his work as a freelance equity analyst. He is a veteran of the Marine Corps and holds the Chartered Financial Analyst (CFA) designation.