If real estate seems to be draped in a fog right now, financial advisors say that for baby boomers looking at this piece of their portfolio, there is one reason to hold it that will burn away the gloom: diversification.

Nearly all financial advisors contacted by National Underwriter say diversification is critical in reducing volatility and increasing return in portfolios and that if the right approach is taken, boomers will benefit from holding it.

Cathy Pareto, a partner and senior financial advisor with Investor Solutions, Coconut Grove, Fla., says her firm accesses the real estate market for clients by using mutual funds that invest in real estate investment trusts. Those REITS, she adds, invest in commercial property that can include apartment buildings and shopping centers as well as international real estate. Mutual fund REITS give clients inexpensive access to real estate, she says.

Pareto says her firm does not time real estate in down markets. The real challenge for boomers, she adds, is controlling volatility in a portfolio and the impact that it can have on wealth. Reducing volatility can increase the rate of return, Pareto continues.

The international piece of the REIT portfolio is focused on developed countries such as the United Kingdom and Japan rather than on emerging markets, she says. The reason, according to Pareto, is that her firm does not want a client’s portfolio exposed to the risk of property seizure in some parts of the world.

Expertise in real estate is advisable if a client is determined to have an actual investment in real estate, she adds. And, if a client already has other investments such as a warehouse or farm, which several of her clients have, then they probably already have a big enough part of their portfolio in real estate, Pareto says.

The important thing for boomers is to maintain liquidity in case of a crisis such as a medical problem, she continues.

Real estate has been a 5%-20% of his clients’ portfolios since 2001, says Peter Canniff, founder and principal with Advanced Portfolio Design, Nashua, N.H. But this year, Canniff says he has backed out of U.S. real estate and has moved to global and foreign real estate mutual funds.

Canniff says he recommends global real estate funds and adds that there is a competitive field of open and closed-end funds as well as exchange traded funds from which to choose.

For most people, he explains, it is best to buy a real estate mutual fund in their IRA or in their variable annuity or life insurance accounts. Many real estate investments, he explains, produce ordinary income that is taxed at the client’s highest tax bracket, so “it’s a little bit smarter if you shelter these in your IRA or Roth IRA.”

Other types of real estate investments such as REITs and limited partnerships become more complex, Canniff continues. Some trade on exchanges every day, and some may not trade at all and you’re stuck with them for 5 or 10 or 20 years, according to Canniff. The most complex real estate investing is starting your own real estate project like buying commercial or residential properties and becoming a landlord, or buying land and developing it for lease or sale, he adds.

There can be some very complex and advantageous issues like tax credit investing for low income housing and some passive income tricks that should be discussed with a CPA when investing directly in real estate (as opposed to buying into a mutual fund), Canniff explains. There are some complex prohibitions around investing in real estate in an IRA if you have decision-making power over the property, he adds.

The real estate market in the U.S. has seen quite a run up over the last decade and it appears the U.S. residential market is in for a slowdown, he says, adding that commercial real estate could follow if the business/economic cycle goes into a contraction. When the stock market has an extended decline, a recovery can often take 2 or 3 years or more. The real estate cycle tends to be longer than that so you may need to wait 3 to 10 years for a full recovery, Canniff says.

The benefit of REITs, according to Kirk Kinder, a certified financial planner with Picket Fence Financial, Bel Air, Md., is the lower correlation to stocks and bonds, and hence, the diversification benefits.

In addition, he notes that REITs have traditionally kept pace with inflation compared with stocks and bonds that lose value to inflation. And, if REITs are purchased through investment vehicles such as exchange traded funds, then costs are minimal, he adds.

Patrick Collins, a principal with Greenspring Wealth Management, Towson, Md., says he uses a fund that invests directly in real estate rather than through REITs. The reason, he says, is he believes REITs are fairly correlated to stocks and clients are better served with a direct exposure to real estate. The fund also invests in commercial property that is valued on cash flow rather than on residential property which is valued on comparable properties. The cash flow property is preferable, he says, because “the residential run-up and then its unwinding may continue to cause problems.”

Unless a client has experience in real estate, Collins says he would never recommend buying property because not only can it be difficult to make money, but there can be a “tremendous amount of headaches” associated with owning property directly.

Bob Nusbaum, president of Middle America Planning, Pittsburgh, agrees that individuals should not invest in narrow holdings or individual properties unless they have expertise. And even then, he continues, “I still would not recommend that they put a tremendous percentage of their portfolio in any one area-unless they are willing to lose most or all of it.” Rather, he suggests a “well-diversified, low-cost index fund.”

Real estate, including international real estate, should form a part of a well diversified portfolio, says Jim Corbeau, a certified financial planner with Maas Capital Advisors, Hillsboro, Ore. But, he continues, since it is also relatively risky as measured by standard deviation, it is used in “relatively small doses.”

Because of its “relative tax inefficiency,” Corbeau says “we prefer to hold real estate investments in a tax-deferred account such as an IRA or a 401(k) whenever possible.”

Barry Kaplan, a certified financial planner with Cambridge Southern Financial Advisors, Atlanta, says the correlation to the S&P 500 is about 0.5 while the return approaches that of the index. “This kind of diversification is the closest thing to a free lunch you can get,” he adds.

“Real estate or REITs are part of that asset allocation for all of our clients. The percentage weighting for each client can differ based on the risk tolerance and need for return,” explains Anthony Benante, a wealth management principal with Baron Financial Group, Fair Lawn, N.J.

With real estate prices dropping and possibly falling even further, it might be a good time for a client to consider buying real estate, says Owen Hill, a certified financial planner with North Lake Tahoe Financial Services, LLC, Incline Village, Nev.

The positive for investing in real estate, he says, is that “rents are not likely to go down while people are abandoning homes throughout the United States.” And, “real estate remains one of the best investments from a tax saving point of view.”

However, he cautions, “A potential real estate investor should, unless very knowledgeable, consult with a financial advisor familiar with real estate investing. How to be a landlord and the tax ramifications are very important to know about before buying.” But, “the major drawbacks are the illiquidity and having to deal with the day to day management.”