You may have heard that "real estate is always a good investment."
However, that’s a "blanket" statement and not terribly useful. In fact, it raises many questions: Does real estate really go up in value all the time? What type of real estate should I invest in? What percentage of my portfolio should be devoted to real estate?
Once you know these answers, you’ll be in a much better position to decide if, and how, you should incorporate real estate into your investment picture.
Of course, real estate investing has been a hot topic over the past several years, as housing prices soared in many areas around the country. Even though the market cooled considerably in 2006, nationwide home prices are up 29.2 percent over the past three years and 64.3 percent over the past five years, according to Business Week magazine. And of all the homes purchased in 2006, 22 percent were bought for investment purposes, according to the National Association of Realtors.
While that 22 percent figure is down from 28 percent in 2005, it indicates that plenty of people are still buying properties in hopes of achieving a source of income, capital appreciation or a combination of both.
If you’re thinking of buying investment property, keep a couple of points in mind. First, contrary to myth, home prices do not always go up. As proven by the results in 2006, housing prices, like stock prices, can - and will - go up and down.
So, don’t buy property with the expectation of constant price appreciation - it won’t happen. The second item to remember is that once you buy property, your investment hasn’t ended - it’s just begun. You’ll need to pay for upkeep, remodeling and property taxes - all of which can be expensive - and you’ll have to find good tenants - which can be a hassle.
Does this mean you should avoid investing in real estate? No. Actually, you may benefit from owning some real estate, because real estate price movements tend to have a low correlation with the price movements of stocks and bonds.
So, if market conditions are hurting the prices of your other investments, your real estate holdings might provide you with a buffer against a more severe drop in your portfolio’s value. But as a general rule, you should probably limit your real estate holdings to no more than 5 percent to 10 percent of your portfolio.
To avoid the expense and potential problems of being responsible for a piece of physical property, you may want to consider shares of a real estate investment trust (REIT), which operates buys, leases and sells commercial and multifamily real estate. You can typically buy REITs in amounts that are appropriate to your needs, and REITs offer diversification by property type and location. (Diversification does not guarantee a profit and does not protect against loss.)
Also, most REITs provide attractive current income, which can help cushion the blow should real estate prices decline or remain stagnant for a long period of time. Income paid on REITs is subject to the individuals tax bracket and does not benefit from the tax reduction on dividends that may be available on equity investments.
Your financial advisor can help you determine if a REIT is suitable for you. If so, you might have found a smart way to get in on "the ground floor" of real estate.
Evans is a financial advisor with Edward Jones in Richmond Hill.