Retirees should consider real estate in portfolio

Posted: Thursday, January 25, 2001

DENVER (AP) -- In the 1970s, real estate was king. Investors couldn't get enough of limited partnerships that bought and sold real estate. But by the 1990s, real estate had become an orphan, shunned in the portfolios of most investors more enamored with stocks and bonds.

Now, in the wake of the stock market's worst showing in years, investors may want to reconsider real estate, says an investment expert at the College for Financial Planning.

''You can't overlook the value of real estate when you analyze your entire portfolio,'' says Michelle Augustine, chairwoman for the Masters of Science-Financial Planning at the College.

While the high-flying tech stocks stumbled in 2000 with their poorest performance in Nasdaq history, and the large-company stocks of the Dow and the S&P 500 didn't do much better, real estate in the form of real estate investment trusts (REITs) returned 25.9 percent for the year, Augustine says. Mutual funds that invest in real estate, primarily through REITs, did nearly as well.

Why should retirees consider real estate, and if they do, how should they invest in it? Augustine points out that savvy investors will likely do better, on average over time, investing in stocks rather than real estate because the long-term returns of stocks historically have been higher than real estate. Also, investing in some types of real estate involves borrowing, and the cost of borrowing further reduces the overall return of the investment.

The problem for stock investors, however, is that stocks can be very volatile from one year to the next, as the year 2000 has so dramatically illustrated. Adding real estate, which does not move up and down in lock step with stocks, dampens some of the volatility of a portfolio weighted with stocks, Augustine says. For example, the strong positive return of REITs in 2000 would have offset some of the down returns of stocks in a portfolio.

''Retirees want to minimize volatility in their portfolios because they don't have the time to recover from a really bad market the way younger investors do,'' Augustine says.

What about your own home? Shouldn't that be treated as real estate and viewed as part of your overall portfolio? Augustine says there is some debate about this among investment experts. On the one hand, a home often is the largest financial investment a family makes. According to the National Association of Home Builders, home prices return an average of seven percent annually, says Augustine. That's not a bad return compared with investments such as bonds.

It's not uncommon for retirees to sell a home and move into a smaller home, using the profits to help fund retirement, Augustine notes. A reverse mortgage that taps into a home's equity also can help fund retirement. Thus, while many people don't think of their home as an investment the same way they view stocks and bonds, the investment return of a home can be significant and can make up a substantial portion of a portfolio.

One of the major problems with counting on your home as your portfolio's main exposure to real estate is that it is a single, very undiversified asset, cautions Augustine. Home prices may average seven percent a year, but in any given location they may rise or fall much more than that. That's where other types of real estate investments can come into play. Augustine suggests three types to consider.

Direct real estate: This might be rental property, an office building, farm or ranch land, or raw land. Augustine says this can provide significant tax benefits and could appreciate handsomely if the location is right. The downside is that direct ownership requires skills in choosing and managing the property, may not provide the desired cash flow, will not be diversified unless you own a lot of real estate, and lacks liquidity if you want to sell it quickly.

REITs: Real estate investment trusts are companies that buy and manage real estate. Typically, they specialize in a type of real estate, such as shopping centers, hotels, office buildings, or warehouses, or they invest in mortgages. One attractive aspect of REITs for retirees is that good REITs kick out a stream of income. Average yields are six to eight percent, with share appreciation averaging an additional four to five percent a year. The tax features of REITs make them especially attractive to investors in higher tax brackets, says Augustine. Unlike direct real estate investments, REITs offer professional management, are diversified and are more liquid because you can buy and sell them like stock.

Mutual funds: Choosing a good REIT can be a bit challenging for investors not familiar with this type of asset, and investing in only one or two REITs doesn't offer much diversification, says Augustine. That's why investing in REITs through mutual funds offers the expertise of professional management and the ability to diversify more widely because mutual funds typically hold numerous REITs.

End advance for Thursday, Jan. 25

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