Adding Property to the Mix

Purchasing real estate has long been a vehicle that investors use to help pad their retirement, but a growing trend among investors these days is to invest a portion of their retirement accounts, like IRAs, in real estate.

Joan Owens, VP of Investment Admin-istrative Services at Fiserv Investment Support Services, which considers itself one of the largest custodians of alternative assets like real estate, says the number of IRA accounts under Fiserv’s administration jumped 18% this year over 2004, and the dollar value of the IRA holders’ property investments over the same period has increased 30%. The 30% increase shows that IRA holders “are making bigger purchases of property” in their IRAs, she says.

The classic argument for investing a portion of one’s IRA–or investment portfolio–in real estate is diversification. For instance, say you have a client who’s rolling over a sizable retirement account from a previous employer into an IRA. It may make sense to invest a portion of the money in the stock market, some in real estate, and some in REITs, Owens says.

Robert Morrison, president of Huber Financial Group in Buffalo Grove, Illinois, says “almost all” of his firm’s clients have exposure to real estate in both IRAs and taxable accounts, primarily in real estate mutual funds. Real estate is the best alternative asset to use nowadays, he says, because it has “a non-correlating relationship to equities.” Because equities correlate so closely with one another, “finding an alternative asset class that creates real diversification has become tougher and tougher,” Morrison says.

Real estate targeted funds, Morrison says, are the best bet these days because they spread out the client’s risk of putting too much money in one particular segment of the real estate market. It’s better to spread a client’s risk across “geographic areas and in industries where you have residential and retail [properties], and industrial real estate investments [to] mitigate some of that risk,” he says.

Depending on a client’s risk level, Morrison says he counsels clients to invest from 5% to 10% of their portfolio, or IRA, in real estate. His firm won’t take clients with less than $400,000 in assets, and “usually half of their investable assets are in IRA-type accounts,” he says. He does caution clients today to consider how much leverage a fund has before investing in it. “A lot of real estate funds and REITs are highly leveraged right now, and while they’ve had fantastic returns in the last couple of years, as interest rates go up they have some risk embedded in them because they’ve leveraged a lot of their assets–meaning they’ve taken on a pretty big debt load.”

Lou Stanasolovich, president of Legend Financial Advisors in Pittsburgh, refrains from investing his clients’ money in real estate because he says more times than not, “it’s the wrong kind of deal.” Particularly now, he says, because “most real estate investments probably won’t do that well going forward because we’re at the top of the cycle because the low interest rates are now rising.” He always steers his clients away from buying homes, especially now as he anticipates the burst of the housing bubble. The only investment that makes sense, he says, “is a commercial lease for a warehouse or manufacturing building where you have the lease locked in for a long period of time, like 10 years, and you know you’re going to get a certain return on your money.”

Morrison agrees, and says that a direct purchase of real estate should be a long-term investment. “People who are buying real estate now with the idea that they are going to flip the property in a year or two, may see the property either flatten out or lose value,” he says. “That’s a high risk, especially in big markets like New York, California, and Florida.” There’s also been a “huge run up” in clients that are interested in buying second homes and vacation homes. The key here is to hang on to it. “For most people, if they’re buying personal use property as a long-term investment, even if the next five years are flat or down, it won’t matter because they’re still using the property,” he says.