By Andrew Altfest, CFP®, MBA, President

At the comprehensive financial planning and investment management firm I lead, we work with many kinds of real estate investors. Some are looking to enter this asset class indirectly as part of their financial independence planning to have another source of income and returns, which can complement their other investments, while others manage multi-property real estate investment portfolios that we help them plan for.

In general, there are many opportunities in real estate. You can buy a property yourself, or you can allocate your investment more passively to publicly traded or private real estate. Whether you decide to buy a property yourself or to take on more indirect exposure to real estate will depend on your desire to manage a property versus simply monitoring an investment strategy.

If you love real estate investing and you want a second job, then you can buy a property and we’ll talk about the tax benefits of investing in real estate. But if you are like many of our clients, you may want to allocate a part of your portfolio to a passive real estate investment strategy, seek ways to do that profitably, enjoy the tax benefits and potentially accelerate your retirement savings.

Let’s look at the range of options that real estate investing offers.

 

Why Invest in Real Estate?

Whether you run a successful practice or have developed good household income during your career, you may still be looking for a way to earn additional passive income that will let you retire comfortably — and possibly early. I’d like to suggest a few ways you can add to or even replace your current income stream with real estate.

Think about what real estate returns have been like in the last few decades. While the last quarter century may not be indicative of the future, since 1996, the U.S. housing market has tripled in value. What’s more, private real estate has outpaced both publicly traded stocks and bonds since 2000. Even more interesting is the fact that private real estate has outpaced stocks with less risk and similar volatility or risk to bonds.[1]

So real estate has been a good place to invest, but I don’t believe it’s going to be so easy going forward. You need a strategy, of which I will suggest a few.

While not guaranteed of positive returns, real estate lends itself to well thought out approaches. For example, you may be able to invest in markets where you can get an edge over other investors, outwork them and remain below the level of competition where the very big institutional investors are. What our firm likes to attempt to do when we invest in real estate for clients is to buy before the property goes on the market, which is known as “off-market.” Once it goes on the market, you have a lot of competition and profits can get squeezed.

[1] Yieldstreet and Bloomberg as of May 31, 2022. Annualized return and standard deviation are calculated on a quarterly basis from Jan. 1, 2000-March 31, 2022. “Private real estate” represents the NCREIF Property Index. “Stocks” represents the S&P 500 Index.

 

Reasons to Gravitate Toward Real Estate

If you can buy off-market, particularly distressed properties, then you may be able to make your money at purchase, which means you buy something at a steep discount compared with where it would sell if it were on the market. Then you’ve got that difference between the price you paid and the market price as an already-embedded gain, or profit.

Real estate also can be a great diversifier in your portfolio. It can zig when other investments zag, which is beneficial. You want to bring together different investments in your portfolio that don’t all move in lockstep.

For example, real estate historically has not moved with stocks. It’s actually shifted a bit in the opposite direction. Think about last year: The stock market and bonds were down, inflation was up, but real estate didn’t do badly.

Let’s look at an example of how taking on debt in a real estate transaction can lead to a potentially higher reward. In the illustration at left below, if you buy a property with $400,000 of pure cash, all equity, then the market goes up 10%, your home is now worth $440,000. You have a $40,000 gain, which is a 10% return.

But let’s say you take your $400,000 and you borrow $600,000 more and buy a property worth $1 million, when the house’s value is up 10%, you now have a gain of $100,000 on a $400,000 investment, which is a 25% return.

Of course, with this additional upside comes additional expense and risk. Recently, investors have been paying much higher rates for loans. And if the million dollar house were to depreciate 20%, you will have lost $200,000 of your money, compared to only $80,000 in a cash only transaction.

Another benefit of owning real estate is that it can be a very good inflation hedge. While the past does not guarantee the future, real estate has historically done well in a higher-inflationary environment like we’re in now. In addition, as a landlord, you are able to increase rent on tenants. And when inflation is high, However, as with all investments, there is an opportunity cost. In a high inflationary environment, other investments may outperform real estate. This, combined with the lack of liquidity that is often associated with real estate, may leave your investment dollars in an underperforming asset that is difficult to change out of.

 

Tax Advantages

As mentioned, real estate also has tax advantages. There are many ways in which you can bypass paying taxes on your profits. That’s quite a statement. What are some of those opportunities?

First, when you own a rental property, you can depreciate the property and that depreciation could offset income that you have coming in, likely from tenants. And in the meantime, your property could be increasing in value, but you can be depreciating it according to an IRS schedule for multifamily properties – you can depreciate it over 27 1/2 years. In effect, you’re collecting income but not all that income is taxable to you. It could be a very good tax deferral strategy.

Among other real estate tax benefits, you might be aware of the exclusion of gain if it’s your primary residence. Generally, if you’re single and you own a property and you sell it, as long as it’s been your primary residence for at least two years of the past five years, you can exclude $250,000 of gain. If you’re married and it’s your primary residence, as a couple you can exclude $500,000 of gain.

Real estate investors also commonly do what are called “1031 exchanges,” in which you can take one property that has done well and sell it, then, rather than realizing the gain, you can roll that into a like-kind investment.

But some real estate investors may never realize that gain when it’s a property that has risen and the owners decide to keep it until they ultimately pass away. However, upon your demise, your heirs get a full step-up in basis, meaning that the cost basis of the property is the current market value of the property, so at that point your heirs can sell the property with no gain, which offers great tax relief. As with all tax strategies, it is best to discuss with a qualified CPA prior to taking action.

 

How Can You Invest in Real Estate?

There are several ways to invest in real estate, depending on what type of risk-return profile you want. One strategy is called “core real estate.” It involves buying trophy properties that are in great condition, have high-quality tenants, are fully leased and located in a prime part of town.

This is what everyone wants. But the return that you get from owning a core asset may be lower than the potential return from owning riskier real estate assets. This strategy usually requires less debt than some others. In the core real estate market, at Altfest we will invest through a fund when we feel core real estate is attractive. However, it may be possible to do better with other strategies in other parts of the real estate market.

Next there’s a strategy called “core plus,” which is similar to core except perhaps the quality of the asset and its location are not as great. The return potential here is higher but probably so is the risk and the amount of debt incurred by investors using this strategy.

Value-add is another real estate strategy to consider. This area is where I see many clients we work with investing when buying properties on their own. This is also where we invest for clients in our private real estate fund.

In value-add real estate, the goal is to place money in properties that can be improved. Perhaps a property is not fully leased, perhaps it’s only 40%-leased. Maybe the property needs to have a lot of capital put into it. But we believe this is where there is the most upside potential. Where there’s psychological aversion, you may be able to gain an edge. Everyone wants something easy; the properties that have more headaches are potentially where there is more opportunity for return.

Finally, there’s another strategy: opportunistic investing. Returns can be high, but you have to be comfortable with the more speculative aspect to it. This approach could include building, anticipating demand and tenants not yet there.

With each strategy, the return potential increases, but of course, so does the risk.

 

Is This a Good Time to Invest in Real Estate?

To answer this question, let’s take a look at two popular parts of the markets in which investors invest. The first is single-family homes, the other is multifamily.

Today, interest rates have moved up significantly, so it costs a lot more to take out a mortgage, but property prices haven’t really come down. That’s because the number of homes available on the market today is historically very low. Real estate is a supply-and-demand game, so low supply is keeping prices high. People are not looking to leave their homes as quickly because they have mortgages at rates no longer available. At the same time, there’s been underbuilding in real estate for many years and that too has supported higher prices.

When it comes to the rental market, vacancy rates are still historically low, so that has been a positive for rents charged and the income derived from properties. But there is a lot of building now in the multifamily market, something for real estate investors to be aware of.

In constructing an investment portfolio that has real estate in it, you have to think about both the public and the private markets. There are times when fear takes over for investors and they don’t want to own publicly traded real estate stocks. You’ll see today that publicly traded real estate is selling on average at a greater-than-8% discount to private real estate, when historically it’s sold at a 2% premium. With this in mind, there could be good buying opportunities in publicly traded real estate.[1]

At Altfest, we recently increased our allocation to publicly traded real estate. Why? When the stock market goes down, publicly traded real estate can fall along with it, even though the underlying assets that are owned by the corporation haven’t gone down in value. There’s also an income component to it, and so if interest rates go up, people might not want to own publicly traded real estate for that reason.

On the public side of this, most are real estate investment trusts, known as REITs. They must pay out a minimum of 90% of their income to investors to keep a tax-preferred structure, so investors don’t have to pay double tax.

In recent years online real estate platforms, also called crowdfunding platforms, have emerged as another place to find investments. With these, you can look at opportunities to invest in someone’s funds or project. I’d be careful with them because you can invest at terms that are not as favorable to you. On some of these platforms, there’s absolutely no due diligence provided, so buyer beware. To provide another option, our firm allocates assets between public and private real estate strategies. We also invest by buying properties in a fund for clients. We are seeking to make our money at purchase, as explained earlier. We are investing primarily through auctions in several U.S. states, seeking to buy the properties at a discount.

[1] Green Street Advisors LLC. Average Premium to Net Asset Value (NAV) Data.8/14/23

 

Deciding the Best Approach for You

So, what should you think about before you invest in real estate? Well, first, what is your investment horizon?

If you’re buying private real estate, it’s not a liquid asset. So, this isn’t money that you’ll want to be calling on in the short term. You have to have a longer time horizon. If you need more liquidity, then you may wish to lean more toward publicly traded real estate. However, even publicly traded real estate may not be appropriate for the short term due to the risk involved.

What’s your risk tolerance? Your risk tolerance will help determine which strategies make the most sense and how much debt you should be taking on.

Finally, how involved do you want to be? If you love doing this, if you wake up on a Saturday morning wanting to start researching real estate or managing your properties, then you could buy a property for yourself and do well potentially. But, like many of our clients considering an allocation in real estate, you may not want to spend the time and effort. This type of investor should consider looking to a passive strategy in real estate.

Clearly, real estate can be a good source of stable income and potentially can help move you ahead on the pathway to retirement. When entering the sector, choose the real estate investment that matches your need for long-term income, your liquidity and expectations for long-term growth, in addition to your time horizon and risk tolerance. If don’t want illiquidity, consider publicly traded real estate, which should allow you to sell and potentially get your proceeds back more quickly.

 

Find Out More

At Altfest, we’re always ready to help you find the most suitable ways to invest in real estate, whether through your own properties, REITS, or our own private real estate strategy. We know everyone’s situation is unique, so reach out to our firm with any real estate investing, portfolio or financial planning questions we can address. Altfest advisors are ready to evaluate your circumstances and offer ideas about how real estate strategies or other assets may be beneficial in maximizing the potential of your portfolio and your financial independence planning.

If you’re not yet an Altfest client, please book some time for a complimentary consultation.

 

 

 

 

 

 

 

 

 

 

 

Investment advisory services provided by Altfest Personal Wealth Management (“APWM”). All written content on this site is for information purposes only. Opinions expressed herein are solely those of APWM, unless otherwise specifically cited. Material presented is believed to be from reliable sources and no representations are made by our firm as to another parties’ informational accuracy or completeness. All information or ideas provided should be discussed in detail with an advisor, accountant or legal counsel prior to implementation. All investing involves risk, including the potential for loss of principal. There is no guarantee that any investment plan or strategy will be successful.